Texas District Court: Equitable Mootness Doctrine Does Not Preclude Appellate Review Of Chapter 11 Plan Exculpation Clause

• Published date: 13 June 2023
• Subject Matter: Litigation, Mediation & Arbitration, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Trials & Appeals & Compensation, Professional Negligence
• Law Firm: Jones Day
• Author: Mr Mark Douglas and Dan Prieto

Exculpation clauses limiting the liability of certain entities for actions taken in connection with a bankruptcy case are a common feature of chapter 11 plans. However, courts disagree over the permitted scope of such clauses. They also disagree as to whether an order confirming a chapter 11 plan that includes exculpation and third-party release provisions is insulated from appellate review under the doctrine of "equitable mootness."

The U.S. District Court for the Southern District of Texas addressed both of these questions in Bouchard v. Bouchard Transportation Co. (In re Bouchard Transportation Co.), 2023 WL 1797907 (S.D. Tex. Feb. 7, 2023). The district court reversed and remanded a bankruptcy court order confirming a chapter 11 plan that included an overbroad exculpation provision, even though the order was not stayed pending appeal, the plan had been substantially consummated, and the plan included a nonseverability provision precluding removal or modification of the exculpation provision. Based on Fifth Circuit precedent, the district court held that, to safeguard the integrity of the chapter 11 process, the doctrine of equitable mootness cannot bar appellate review of an order confirming a plan that contains an impermissibly broad exculpation provision.

Validity of Third-Party Releases and Exculpation Clauses

Section 524(e) of the Bankruptcy Code provides that, "[e]xcept as provided in subsection (a)(3) of this section [making the discharge injunction applicable to actions to collect against community property], discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt." Even so, chapter 11 plans confirmed by bankruptcy courts in certain circuits commonly include provisions that either release or exculpate various non-debtors from certain liabilities.

Such releases can provide for the relinquishment of both prepetition and postpetition claims belonging to the debtor or non-debtor third parties (e.g., creditors or shareholders) against various non-debtors.

Exculpation clauses, by contrast, typically specify the scope of, or the standard of care (e.g., ordinary negligence, gross negligence, or willful misconduct) governing, an exculpated party's liability for conduct during the course of the bankruptcy case. See In re Aegean Marine Petroleum Network Inc., 599 B.R. 717, 721 (Bankr. S.D.N.Y. 2019) (noting that "an appropriate exculpation provision should say that it bars claims against the exculpated parties based on the negotiation, execution, and implementation of agreements and transactions that were approved by the Court"); In re Murray Metallurgical Coal Holdings, LLC, 623 B.R. 444, 501 (Bankr. S.D. Ohio 2021); see also Blixseth v. Credit Suisse, 961 F.3d 1074, 1084 (9th Cir. 2020) (distinguishing releases and exculpation clauses), cert. denied, 141 S.Ct. 1394 (2021). Exculpation clauses typically insulate estate fiduciaries, including officers, directors, and employees of the debtors and the reorganized debtors, as well as advisers and professionals retained by the estate, from most claims arising from their conduct during the chapter 11 case. See, e.g., In re PWS Holding Corp., 228 F.3d 224, 246 (3d Cir. 2000).

Although it is generally accepted that a chapter 11 plan can release non-debtors from claims of other non-debtor third parties if the release is consensual, courts disagree over whether a bankruptcy court has the authority'either constitutionally or under the Bankruptcy Code'to approve such releases over the objections of creditors or other stakeholders as part of a chapter 11 plan in a non-asbestos bankruptcy case. See 11 U.S.C. ' 524(g) (providing for the creation of a trust to fund the payment of claims and the issuance of a channeling injunction in asbestos chapter 11 cases); see generally Collier on Bankruptcy ' 524.05 (16th ed. 2023) (discussing cases and noting that "Courts have disagreed over whether section 524(e) prohibits a provision of a confirmed plan under chapter 11 or under any of the other rehabilitation chapters that provides for releases for third parties (that is, parties other than the debtor)").

The circuit courts of appeals disagree over whether nonconsensual third-party releases and exculpation provisions are barred by section 524(e). The minority view, held by the Fifth and Tenth Circuits, is that such provisions are categorically precluded by section 524(e) absent express authority in another provision of the Bankruptcy Code (e.g., 11 U.S.C. ' 1103(c), which has been interpreted to limit the liability of members of official committees to liability for willful misconduct or ultra vires acts). See Bank of N.Y. Trust Co. v. Official Unsecured Creditors' Comm. (In re Pacific Lumber Co.), 584 F.3d 229 (5th Cir. 2009); Landsing Diversified Props. v. First Nat'l Bank & Tr. Co. of Tulsa (In re W. Real Estate Fund, Inc.), 922 F.2d 592 (10th Cir. 1990). By contrast, the Second, Third, Fourth, Sixth, Seventh, Ninth, and Eleventh Circuits read section 524(e) to allow varying degrees of limited third-party releases and exculpations. See In re Metromedia Fiber...