In re Boy Scouts of America and Delaware BSA, LLC: Delaware District Court Affirms Bankruptcy Court’s Approval of Third-Party Releases, in Conflict with Southern District of New York District Court in Purdue

Background

BSA is a well-known nationally recognized nonprofit organization. To accomplish its mission, BSA relies on many Local Councils and Chartered Organizations to operate individual scout units at a local level. Prior to the BSA bankruptcy cases, BSA, Local Councils, and Chartered Organizations were named co-defendants in hundreds of lawsuits alleging sexual abuse within the scouting ranks (“Abuse Claims”), and BSA was also then aware of 1,400 other similar claims not yet the subject of lawsuits. On October 18, 2020, BSA filed chapter 11 bankruptcy cases in the Bankruptcy Court for the District of Delaware.

The Plan and Releases: Among other things, the Plan proposed a global resolution of Abuse Claims against the debtors, related non-debtor entities, Local Councils, Contributing Chartered Organizations, Settling Insurance Companies, and their respective Representatives. The central feature of the Plan was the establishment of a settlement trust (the “Settlement Trust”) to which Abuse Claims would be channeled. The Plan also contained three sets of releases, including certain third-party releases by holders of the channeled Abuse Claims in favor of non-debtor Local Councils, Chartered Organizations, Settling Insurance Companies, and their respective Representatives (collectively, the “Releasees” and the third-party releases, the “Releases”).

The Bankruptcy Court’s Confirmation Order: On July 29, 2022, the Bankruptcy Court found it had jurisdiction to approve, and did approve, the Releases, and on September 8, 2022, the Bankruptcy Court entered its order confirming the Plan.

Objections: Two sets of holders of Abuse Claims (the “Lujan Claimants” and the “D&V Claimants,” collectively, the “Claimants”) appealed the Bankruptcy Court’s Confirmation Order arguing that: (1) the Bankruptcy Court lacked subject matter jurisdiction to approve the channeling injunction and Releases; (2) the Bankruptcy Court lacked statutory authority to approve the channeling injunction and Releases; and (3) the channeling injunction and Releases did not satisfy applicable Third Circuit precedent set forth in In re Continental.⁴

District Court Decision

Jurisdictional Authority: The District Court agreed with the Bankruptcy Court that it had “related to” jurisdiction over the third-party claims being released due to: (a) a clear identity of interest and interconnectedness among BSA and the other Releasees, who each benefit from the channeling injunction and Releases; (b) the shared insurance coverage among BSA, the Local Councils, and the Chartered Organizations, which, if depleted, would reduce the property of BSA’s estate that would otherwise be available for distribution to creditors; (c) contractual indemnification obligations among BSA, Local Councils, and certain of the other Releasees, including Chartered Organizations and BSA’s Representatives, which, when triggered, would deplete property of the estates; and (d) BSA’s residual interest in all Local Council property. While the Bankruptcy Court had declared that it had “arising in” jurisdiction but, “notwithstanding” that, it also had “related to” jurisdiction, the District Court carefully distinguished between the two jurisdictional grounds — determining that “arising in” jurisdiction existed over the confirmation proceeding but that, at a minimum,⁵ “related to” jurisdiction existed with respect to the Bankruptcy Court’s approval of the Plan’s third-party releases:

Whether the analysis is characterized as jurisdictional or as a determination of the merits, it is clear to me that the permissibility of third-party releases does not end with whether the Bankruptcy Court had “arising in” or “arising under” jurisdiction to confirm the Plan containing them. Rather, a separate analysis is required with respect to a Plan’s release of claims and/or suits between third parties. As Third Circuit law currently stands, that separate analysis is described as jurisdictional: “Bankruptcy court jurisdiction potentially extends to four types of title 11 matters: [including] . . . Proceedings ‘related to’ a title 11 case[, which] include causes of action owned by the debtor that become property of the bankruptcy estate under 11 U.S.C. § 541(a), as well as suits between third parties that conceivably may have an effect on the bankruptcy estate.”⁶

As noted in the Opinion, in “related to” non-core proceedings, the bankruptcy court may only hear and issue proposed findings of fact and conclusions of law for district court review unless all parties consent. Even though the Confirmation Order purported to be a final order of the Bankruptcy Court on appeal to the District Court, the District Court nevertheless decided it did not have to determine whether there was “arising in” jurisdiction regarding the channeling injunction and Releases, given it had concluded that the Bankruptcy Court “at a minimum” had “related to” jurisdiction.

Statutory Authority: The District Court concluded that the Bankruptcy Court had the requisite statutory authority under Bankruptcy Code §§ 105(a), 1123(a)(5), and 1123(b)(6) to approve the channeling injunction and the Releases. Consistent with other courts in the Third Circuit, the District Court viewed these Bankruptcy Code sections as collectively conferring upon bankruptcy courts a “‘residual authority’ to formulate plans that enable successful and value-maximizing reorganizations, including [approving] relief not specifically authorized elsewhere in the Bankruptcy Code.”

The District Court also rejected Claimants’ arguments that the channeling injunction and the Releases are prohibited under §§ 524(e) and 524(g) of the Bankruptcy Code. First, the District Court — relying on Third Circuit precedent — rejected Claimants’ argument that the express terms of § 524(e) bar non-consensual third-party releases. Next, the District Court agreed with the Bankruptcy Court’s conclusion that the express authority given under § 524(g) to approve certain third-party releases in the asbestos context does not render third-party releases impermissible in non-asbestos cases.

Third Circuit Precedent under In re Continental: After concluding that the Bankruptcy Court had subject matter jurisdiction and statutory authority to approve the channeling injunction and Releases, the District Court evaluated Claimants’ arguments that the channeling injunction and Releases did not satisfy the governing Third Circuit standards for permissible nonconsensual releases. Specifically, Claimants argued that the channeling injunction and Releases: (1) were not necessary to the reorganization because prior iterations of the Plan, including a BSA-only toggle plan, did not contain the channeling injunction or the Releases and (2) were not fair because the Local Councils and Chartered Organizations did not provide sufficient consideration in exchange. The District Court concluded that Claimants’ arguments misconstrued the legal standard articulated in Continental, and Claimants failed to show that the Bankruptcy Court erred in its underlying factual findings and analysis supporting necessity and fairness of the channeling injunction and Releases.

Necessary to the Reorganization: The District Court found no error in the Bankruptcy Court’s determination that the Releases were necessary to the Debtor’s reorganization. Specifically, the District Court observed:

• There is no evidence that the prior iterations of the proposed plans (which had not yet been solicited) would have been feasible — either for the future of BSA or as a means of providing compensation to holders of Abuse Claims;
• Approval of the channeling injunction and the Releases in favor of the Local Councils and Chartered Organizations allows such entities to resolve their abuse liabilities and continue to deliver the Scouting Program in order to maintain and recruit Scouts, which in turn generates revenue necessary for the feasibility of the Plan; and
• Contributions to the Settlement Trust by the Releasees of approximately $2.5 billion in cash and property, as well as other assets the Bankruptcy Court determined have a value of more than $4 billion, would not have been made but for the channeling injunction and Releases; therefore, approval of the channeling injunction and Releases were necessary in order to maximize value of the estates for holders of Abuse Claims.

Fairness: The District Court, likewise, concluded that Claimants failed to demonstrate error in any of the Bankruptcy Court’s factual findings and analysis supporting the fairness of the channeling injunction and Releases. Primarily, Claimants challenged the sufficiency of consideration given by the Releasees in exchange for the Releases and argued that they are being forced to release claims against Releasees “while receiving little to nothing in exchange.” Focusing on the consideration received by the parties whose claims are being released, and not the cost imposed on the released parties, the District Court rejected this argument and explained that because Claimants will receive under the Plan the full compensation to which they would be entitled in the tort system, they are receiving “adequate consideration” as required by Continental. The District Court also pointed to the following as evidence of fairness of the channeling injunction and Releases:

• Over 85% of Direct Abuse Claimants, as a class, accepted the Plan and such acceptance constitutes overwhelming acceptance;
• Key stakeholders, such as JP Morgan Chase Bank, the Creditors’ Committee, the Tort Claimants’ Committee, the Future Claimants’ Representative, the Coalition, and the Settling Insurance Companies supported the Plan; and
• The settlements embodying the channeling injunction and Releases are preferable to the alternative (e., litigation and potential cents-on-the-dollar recovery under a BSA-only plan) after conducting an exhaustive review of, among other things, the fairness of the settlements and impediments to collection.

Key Takeaways

The Opinion is the latest example of the lack of uniformity across the circuits on the issue of whether bankruptcy courts have statutory and constitutional authority to approve third-party releases.

While it continues to be common practice for parties to use and rely on third-party releases to maximize value and enhance creditor recoveries, third-party releases continue to be controversial and at the forefront of conflicting rulings in high-profile chapter 11 cases. The lack of judicial uniformity as to third-party releases impacts not only settlements and deal-making but also the bankruptcy courts’ ability to approve on a final basis the plans that contain them. We and other practitioners are eager for the Second Circuit’s long-awaited ruling in Purdue that will solidify that particular circuit’s views on this important issue, and now also await developments in the Third Circuit appeals in this case now that the District Court and Third Circuit have denied Appellants’ request for stay pending appeal, although those appeals may be mooted as a result of the Plan going effective on April 19, 2023. We also continue to keep a watchful eye on the Supreme Court, which is currently considering granting certiorari in the Highland Capital Management case,⁷ which could potentially address the enforceability of non-debtor third-party releases.

¹Nat’l Union Fire Ins., Co. of Pittsburgh, Pa. et al v. In re Boy Scouts of Am. & Delaware BSA, LLC et al (In re Boy Scouts of Am. & Delaware BSA, LLC), No. 20-10343-LSS (the “Bankruptcy Case”), 2023 WL 2662992 (D. Del. Mar. 28, 2023).

²For a discussion of the Confirmation Order (Supplemental Findings of Fact and Conclusions of Law and Order Confirming the Third Modified Fifth Amended Chapter 11 Plan of Reorganization (with Technical Modifications) for Boy Scouts of America and Delaware BSA, LLC [D.I. 10316 (Bankruptcy Case)] (Sept. 8, 2022) along with the Bankruptcy Court’s opinion on confirmation issues, including the propriety of third-party releases, In re Boy Scouts of Am. & Delaware BSA, LLC, 2022 WL 3030138 (Bankr. D. Del. July 29, 2022)), see Another Delaware Bankruptcy Court Approves Third-Party Releases and Opt-Out Mechanisms Amidst Disagreements with Other Circuits, VELaw.com (Aug. 26, 2022).

³In re Purdue Pharma, L.P., 635 B.R. 26 (S.D.N.Y. 2021). For more information on the Purdue ruling and third-party releases in general, see In re Purdue Pharma L.P.: S.D.N.Y. Holds Bankruptcy Court Lacks Statutory Authority to Approve Sackler Family Releases, VELaw.com (Dec. 28, 2021). In Purdue, the United States District Court for the Southern District of New York vacated Purdue’s plan of reorganization on the basis that the bankruptcy court did not have statutory authority to approve the non-debtor third-party releases contemplated therein. The plan proponents appealed that decision to the Second Circuit, which held oral argument on the matter on April 29, 2022. The appeal remains pending.

And for more information on yet another recent third-party release opinion from the Eastern District of Virginia, see District Court in Virginia Continues Questioning of Third-Party Releases – At Least in the Absence of Detailed Findings of Necessity, VELaw.com (Jan. 25, 2022).

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

⁵Opinion, at *18.

⁶Id. at *17 (citing In re Combustion Eng’g, 391 F.3d 190, 225-26 (3d Cir. 2004)).

⁷In In re Highland Capital Management, L.P., the Fifth Circuit recently struck plan provisions providing for exculpation of certain non-debtor third parties because, according to the Fifth Circuit’s minority view, § 524(e) does not permit a plan to discharge non-debtor parties. 48 F.4th 419 (5th Cir. 2022) (cert. petitions filed, Nos. 22-631 (U.S. Jan. 9, 2023) and 22-669 (U.S. Jan. 20, 2023)). The cert petitions ask the Supreme Court to review the meaning and interpretation of § 524(e) and the permissible scope of plan exculpations, respectively. As of the date of this writing, the Supreme Court has not yet granted or denied either petition, but both have been distributed for conference on May 11, 2023.