Consent in a Post-Purdue World

By: Gabrielle Albert, Keller Benvenutti Kim LLP.

In the wake of the United States Supreme Court’s Harrington v. Purdue Pharma L.P.[1] decision definitively doing away with nonconsensual third-party releases, courts and practitioners alike have been struggling with the meaning of “consensual” in the context of such releases.  One such jurist is the District of Delaware’s Judge Craig Goldblatt who tackled the issue in the recent In re Smallhold Inc.[2] decision.

Before Purdue, the Third Circuit[3] allowed non-consensual third-party releases if the bankruptcy court found “fairness, necessity to the reorganization, and specific factual findings to support [those] conclusions.”[4]  Under that framework, prior to the Purdue decision, Judge Goldblatt had approved the debtor’s plan, including non-consensual third-party releases.  That plan had four classes:

1. Class 1 secured claim – payment negotiated with debtor;
2. Unclassified priority claims – paid in full; claimants deemed to accept the plan;
3. Class 2 general unsecured creditors – pro rata distribution; class members given the option to opt out of the third-party releases by checking a box on plan ballots; and
4. Equity interests – no distribution; interest holders deemed to reject the plan.

Importantly, Class 2 creditors who failed to vote were not subject to the third-party releases.

The court approved the plan with the proviso the releases could be revisited once the Supreme Court decided Purdue.  After its publication, Judge Goldblatt reassessed the third-party releases under the new law from the Purdue decision.  The Smallhold opinion discussed here is the result of that post-Purdue review.

The Purdue Decision

The Purdue decision held “that the bankruptcy code does not authorize a release and injunction that, as part of a plan of reorganization under Chapter 11, effectively seeks to discharge claims against a nondebtor without the consent of affected claimants.”[5]  Now, “a creditor cannot be deemed to consent to a third-party release without some affirmative expression of the creditor’s consent.”[6]  But what is “consent” in this context?  The Purdue decision did not define consent, instead leaving that to the lower courts.

Is the Release an Enforceable Contract?

Prior to Purdue, the Third Circuit allowed consent to be found by default under the “fairness” test discussed above.  After Purdue, Judge Goldblatt had to review consent with a fresh lens.  First, he found that consent could not be established by default.  While courts enter orders every day imposing their will on parties by default, “in those examples, there is consistently a basis in either the Bankruptcy Code or the Federal Rules of Bankruptcy Procedure or other substantive law contemplating and authorizing that relief.”[7]  Second, he found that outside of the bankruptcy context, parties’ rights can be taken based on statutory authority or given away by contract.  Since the Supreme Court held that the Bankruptcy Code[8] contains no such statutory authority, the only way for creditors to consent was contractually.  “[S]uch releases were only appropriate in circumstances in which, following a contract model, there was evidence of an agreement to grant that release.”[9]

Under contract law, an agreement can only be proven by a party’s action, not by a lack of it.

Imagine that Party A, after hitting Party B’s car in the parking garage, wrote a letter to Party B, stating that unless Party B responded to the letter in 10 days, Party B would be obligated to release any claim she might have against Party A in exchange for a payment of $100.  No court would treat Party B’s failure to respond as “consent” to those terms in a way that bound Party B to release her claim against Party A. Treating the failure to check a box on a ballot in bankruptcy is no different.[10]

Moreover, if creditors are not provided ballots because they were either deemed to accept or reject the plan as the priority claimants and equity holders were, they do not have the option to voice their acceptance or denial of the requested third-party releases.  Those creditors’ lack of objection in the face of the plan’s proposed releases was insufficient to bind them under ordinary contract law principles.  Therefore, Smallhold’s third-party releases could not be imposed on the unclassified claimants and equity holders.

On the other hand, the Class 1 secured lender had negotiated an arrangement with the debtor by which it would approve the plan.  The court held that this agreement was sufficient to find that the secured lender had consented to the releases.

For the class 2 general unsecured creditors who voted on the plan, Judge Goldblatt held that their votes, regardless of how they voted, coupled with the ballot’s clear instructions and simple mechanism to opt out of the releases, constituted an affirmative step sufficient to find consent under contract law.  The court ruled that the act of returning the ballot was sufficient to constitute an affirmative, and thus binding, action.

What about claimants who failed to vote?  That issue was not before the court because “nothing in this solicitation process imposed a third-party release on a class 2 creditor who never returned a ballot.”[11]

Finally, the court noted that other tools, such as exculpations, releases of estate causes of action, and potentially incorporating the class action protections of Federal Rule of Civil Procedure 23 into the plan process, were open to creative lawyers and could still achieve the finality objectives of third-party releases.

In short, Judge Goldblatt concluded that the Third Circuit’s prior rule, in which a plan could impose releases on all creditors except for those who voted to opt out, did not survive Purdue.  Instead, a creditor may only release a third party from future liability by demonstrating its intent to do so by discernable action such as returning a ballot that includes the option to opt out of those releases.

Final Thoughts

While the Smallhold decision provides clear guidance for evaluating consent by individual creditors who vote on a plan, it leaves significant questions unanswered – Is an opt-out plan sufficient or is the higher hurdle of an opt-in plan required depending on the circuit?  Do the released parties need to go through their own pre-pack cases to get releases as is reportedly being contemplated in In re The Roman Catholic Diocese of Rockville Centre, New York?  These and other unanswered questions will surely be the source of heated debate and creative lawyering for years to come.

[1] 219 L. Ed. 2d 721 (2024).

[2] In re Smallhold, Inc., 2024 Bankr. LEXIS 2332 (Bankr. D. Del. 2024).

[3] The Second, Fourth, and Sixth Circuits also allowed non-consensual third-party releases under their own tests.

[4] Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 214 (3rd Cir. 2000).

[5] Harrington v. Purdue Pharma L.P., 219 L. Ed. 2d at 739-740.

[6] In re Smallhold, Inc. at *10.

[7] Id. at *37 (internal citations omitted).

[8] 11 U.S.C § 101 et seq.

[9] In re Smallhold, Inc. at *38.

[10] Id. at *6.

[11] Id. at *13.