District Court Finds Plan Provision So Broad It Exceeded Jurisdiction

While bankruptcy subject matter jurisdiction is broad, sometimes an order can just go too far as shown by the recent opinion from the U.S. District Court for the Eastern District of Virginia in Patterson v. Mahway Bergen  Retail Group, Inc., 2022 U.S. Dist. LEXIS 7431 (E.D. Va. 2022).

The Three Types of Jurisdiction

Bankruptcy practitioners can usually recite the three types of bankruptcy jurisdiction in their sleep: arising in, arising under and related to. Of these, related to is the broadest. In the Fifth Circuit, related to jurisdiction is present if the matter being addressed could have a conceivable effect on the debtor or the bankruptcy estate. Thus, if the debtor owned a store at the bottom of a hill and a property owner had allowed a boulder at the top of the hill to work precariously loose, an adversary proceeding to force the other property owner to secure the boulder would have a conceivable effect on the bankruptcy estate and related to jurisdiction would be present. Why is this? If the boulder rolled down the hill, it could smash the debtor's store. On a more mundane note, there is related to jurisdiction to collect accounts receivable owed to the debtor because collecting money would make it easier to reorganize.

In the past, there were many arguments about whether bankruptcy courts had jurisdiction to grant third-party releases. The Supreme Court put this controversy to rest in United Student Aid Funds v. Espinosa, 559 U.S. 260 (2010). In that case, the Supreme Court drew a distinction between having statutory authority to take an action and having jurisdiction to do so. The Bankruptcy Code does not allow a court to grant a hardship discharge on a student loan without filing an adversary proceeding. However, there is clearly jurisdiction to do so because granting the discharge would have a conceivable effect on the debtor. What this means is that if a plan contains a provision which should not be approved, the parties have to challenge it directly as opposed to coming back years later and saying that there was no jurisdiction to approve the provision.

A Broad Release

As broad as bankruptcy court jurisdiction is, it is hard to find something that could conceivably come up in a bankruptcy case that would not have a conceivable effect on the debtor or the estate. However, the opinion in the Mahway Bergen case found just such a provision. The provision was included among the third-party releases in the plan. Under the plan, these releases were binding on anyone who either voted in favor of the plan or who voted against or abstained from voting but didn't object to the plan or affirmatively opt-out.  The release released any and all claims, known or unknown, related to 

the Debtors (including the management, ownership or operation thereof), the purchase, sale, or rescission of any Security of the Debtors or the Reorganized Debtors, the subject matter of, or the transactions or events giving rise to, any Claim or Interest that is treated in the Plan, the business or contractual arrangements between any Debtor and any Released Party, the Debtors' in- or out-of-court restructuring efforts, intercompany transactions, the ABL Credit Agreement, the Term Loan Credit Agreement, the Chapter 11 Cases, the Restructuring Support Agreement and related prepetition transactions, the Backstop Commitment Letter, the Disclosure Statement, the New Corporate Governance Documents, the Exit Facilities, the Plan (including, for the avoidance of doubt, providing any legal opinion requested by any Entity regarding any transaction, contract, instrument, document, or other agreement contemplated by the Plan or the reliance by any Released Party on the Plan or the Confirmation Order in lieu of such legal opinion), the filing of the Chapter 11 Cases, the pursuit of Confirmation, the pursuit of Consummation, the administration and implementation of the Plan, including the issuance or distribution of Securities pursuant to the Plan, or the distribution of property under the Plan or any other related agreement, or upon any other act, omission, transaction, agreement, event, or other occurrence (in each case, related to any of the foregoing) taking place on or before the Effective Date.

In the District Court’s view, the Bankruptcy Court clearly lacked jurisdiction over some of the releases.

Although the Court cannot determine precisely which Released Claims the Bankruptcy Court could have adjudicated, it takes only a cursory review of the Third-Party Releases and the Releasing Parties to find released claims that the Bankruptcy Court lacked the authority to adjudicate. The universe of released claims includes claims between non-debtors which may have no connection to the property of Mahwah's bankruptcy estate or the administration of the Bankruptcy Proceeding. For example, the Third-Party Release would bar securities claims, such as those brought by the Securities Plaintiffs, against former directors and officers of Mahwah, even if the claims arose before Mahwah filed for bankruptcy and those directors and officers had no involvement in the Bankruptcy Proceeding. And it bears noting that "federal courts disfavor indemnity for federal securities law violations, calling into question the enforceability of these obligations."(citation omitted). Thus, the only type of released claim that the Bankruptcy Court actually considered finds antipathy in the case law.

2022 Bankr. LEXIS at *46-47.

What Does It Mean?

This is a case of drafting that was too clever by half. The author threw in lots of specific things that were subject to the release and were clearly related to the plan process. However, the very first line released all claims related to "the Debtors (including the management, ownership or operation thereof)." Thus, if a forklift operator at one of the debtor's warehouses dropped a pallet on the foot of another employee of the debtor that would be a claim arising from the operation of the Debtors and hence subject to the release. 

Reading between the lines, the intent here may have been to cut off securities liability for the Debtor's officers and former officers. I suggest this because the release specifically included claims arising from "the purchase, sale, or rescission of any Security of the Debtors." Additionally, one of the appellants in the case was the putative class representative in a securities law class action. Elsewhere in the opinion, the District Court pointed out that the release officers and directors were getting more relief than they could have received in their own bankruptcy proceedings since securities fraud claims are non-dischargeable under 11 U.S.C. Sec. 523(a)(19). Ironically, there probably was jurisdiction to release these claims since the officers and directors might have had indemnity rights against the debtors or perhaps the debtors would have had to pay deductibles on D & O insurance. However, if the intent was to cut off the securities litigation, debtor's counsel used a nuclear bomb to swat a fly.

The lesson from this opinion is that although bankruptcy jurisdiction is broad, it is not all-encompassing. Sometimes there will be grounds to object to subject matter jurisdiction.  

On a related note, this is the second district court opinion in six months to find fault with third-party releases. The same thing happened in the Purdue Pharma case. This may be a case of District Judges diligently discharging their responsibility as first level appellate judges in bankruptcy cases. However, it might also signal that at least some Article III judges feel like the Article I bankruptcy judges are getting a little bit too big for their britches. Reading the language in this opinion and the Purdue Pharma opinion, there is a palpable sense that mega bankruptcy cases have become an anything goes free-for-all.  This is troubling because there have been two Supreme Court cases dealing with the power of the Article I courts: Marathon Pipeline and Stern v. Marshall. Each of these decisions brought chaos to the bankruptcy world. If Chief Justice Roberts is watching this issue, we may be in line for a third smackdown on the power of the bankruptcy courts.