January 26, 2022 - Less than a month after a momentous decision by a District Court judge in New York striking down the confirmed plan of reorganization in the Purdue Pharma bankruptcy, a judge in Virginia struck down the third-party releases that were part of the Mahwah Bergen Retail Group (f/k/a Ascena) plan. While the underlying legal issue in both cases was the permissibility of third-party releases (we reviewed the Purdue Pharma case here), the elephant in each courtroom was the issue of rampant bankruptcy forum shopping by debtors. This note will briefly review the Virginia court’s decision, summarize its possible implications for the loan market, and end with an explanation how forum (and judge) shopping is at the center of these cases and other controversial bankruptcy cases.
The Mahwah case. The case involved the bankruptcy of Ascena Retail Group which had owned such brands as Ann Taylor, Loft and Lane Bryant. The debtor liquidated most of their assets through Section 363 sales in the bankruptcy and the proposed plan provided for the distribution of the remaining cash in the estate. The plan included extensive third-party releases covering any claims that existed or could have been brought against anyone associated with the debtor and bound anyone who did not affirmatively opt out of the releases. Because of the opt-out provision, the bankruptcy court treated the releases as consensual and conducted no analysis of whether the releases were constitutional, whether the nature of the claims were “core” or “non-core”, whether the opt-out notices were effective and, finally, whether the releases conformed to the requirements set forth in the Fourth Circuit’s precedent-setting case on third-party releases, Behrmann v. Nat’l Heritage Found. The district court ruled that the releases at issue had no relationship with or effect on the bankruptcy proceeding and were therefore non-core. He also found that the plan was non-consensual, notwithstanding the opt-out provision. Thus, the bankruptcy court had no Constitutional authority to issue a final order and could only be treated as an advisory opinion subject to review by the district court. The court then analyzed whether the releases in this case conformed to the requirements of Behrmann. Applying a seven-pronged test, the court ruled that the releases did not. (For a deeper analysis of the case please see this helpful memo by Schulte).
Implications. While third-party releases are theoretically permissible in the 4th Circuit, as a practical matter, this case imposes very significant barriers to their use. As Schulte notes, “The need for a Bankruptcy Court to determine whether every claim released by third-party releases is a core or non-core claim will require that a debtor specifically identify each claim to be released and provide an explanation of how the claim relates to the bankruptcy case. And, the Bankruptcy Court will be required to conduct a full Behrmann analysis for non-consensual third-party releases (and consent cannot be obtained by a failure to opt out). In the face of these evidentiary burdens, debtors may well be forced to more narrowly tailor any third-party releases contained in a plan.”
What does this have to do with forum shopping? It is arguable that this case, like several other recent retail cases, was brought in the bankruptcy court in Richmond Virginia because of its reputation for approving broad third-party releases. As the court noted, the “ubiquity of third-party releases in the Richmond Division demands even greater scrutiny of the propriety of such releases.” Similarly, in Purdue, the debtor handpicked the bankruptcy court in White Plains, New York, because Judge Robert Drain, the only bankruptcy judge in that court, had a reputation for approving third-party releases (and, in that case, the third-party releases were the linchpin of the entire case). We have written frequently about the perceived abuses resulting from bankruptcy forum shopping and the legislation designed to end it. While many academics and legislators have advocated to reform these rules, by rejecting third-party releases district courts in two of the most popular bankruptcy venues in the country may have done more to impact bankruptcy forum shopping than anyone else.