Restructuring

Overview

Two bills were recently introduced in Congress to amend certain sections of title 11 of the United States Code (the “Bankruptcy Code”) and title 28 of the United States Code (the “Judicial Code”) that, if enacted, could greatly impact several of the most controversial topics in current corporate restructuring practice today, including (i) non-debtor third-party releases, (ii) the extension of the automatic stay to non-debtor third-parties, (iii) the use of chapter 11 for companies that have undergone divisional merger transactions to separate assets and liabilities within ten years prior to filing, and (iv) chapter 11 venue.  These bills are the:

• Nondebtor Release Prohibition Act of 2021 (the “NRPA”), and
• Bankruptcy Venue Reform Act of 2021 (“BVRA”).

Furthermore, bankruptcy courts for the Southern District of New York and the Eastern District of Virginia – two popular jurisdictions for chapter 11 cases – also recently announced changes to their respective judge assignment protocols for mega chapter 11 cases to ensure random assignment among all judges in the district regardless of the division a case is filed in. 

This Article provides a high-level overview of the NRPA and BVRA as well as the recent judge assignment protocol changes.

Nondebtor Release Prohibition Act of 2021

Overview

On July 28, 2021, Representatives Jerrold Nadler (D-N.Y.), Carolyn Maloney (D-N.Y.), David Cicilline (D-R.I.), Peter DeFazio (D-Oreg.), and Katie Porter (D-Calif.) introduced the NRPA in the House of Representatives, and Senators Elizabeth Warren (D-Mass.), Richard Durbin (D-Ill.), and Richard Blumenthal (D-Conn.) introduced an equivalent bill in the Senate.  On November 3, 2021, the House Judiciary Committee voted to send the NRPA to the full House of Representatives for consideration pursuant to a 23-17 vote, which was split mostly across party lines. 

The NRPA proposes, among other things, to (i) prohibit bankruptcy courts from approving nonconsensual third-party releases of claims against non-debtors (with limited exceptions), (ii) limit the ability of bankruptcy courts to enjoin claims against (i.e., extend the automatic stay to) non-debtors beyond 90 days, and (iii) require the dismissal of chapter 11 cases commenced where the debtor has undergone a divisional merger or equivalent transaction or restructuring in the 10 years prior to the petition date.  Importantly, as proposed, the NRPA would take effect on the date of its enactment and apply to any chapter 11 case pending as of that date or filed on or after the date of enactment.

As of the date of this Article, the Senate Judiciary Committee has yet to vote on the NRPA and consideration of the NRPA by the full House has not yet been scheduled.

Current State of Third-Party Releases

As mentioned previously (and frequently) in the Restructuring Review, including here, here and here, there is significant judicial discord amongst courts on the permissibility and standards for approving provisions in a debtor’s chapter 11 plan that seek to release claims against non-debtor third parties without the consent of the releasing parties (i.e., “nonconsensual third-party releases”), as well as the standards for determining what constitutes consent for the less controversial “consensual” third-party releases.  For example, can consent to the release be deemed from a party’s failure to affirmatively opt out of the release?

The most high profile decision on the issue of releases was in Purdue Pharma, which we recently wrote about here, where the District Court for the Southern District of New York overturned an order of the Bankruptcy Court for the Southern District of New York confirming Purdue’s chapter 11 plan on the ground that it included nonconsensual third-party releases in favor of the Sackler family (the long-time owners of Purdue) and other non-debtor third parties.  In doing so, the District Court found that the Bankruptcy Code does not provide courts with the statutory authority to grant nonconsensual third-party releases outside of the asbestos context. 

Shortly after the District Court’s decision in Purdue Pharma, the District Court for the Eastern District of Virginia vacated an order of the Bankruptcy Court for the Eastern District of Virginia confirming the chapter 11 plan of the debtors in Ascena Retail Group and invalidated the plan’s third-party releases.  See Patterson v. Mahwah Bergen Retail Grp., Inc., No. 3:21cv167 (DJN), 2022 WL 135398 (E.D. Va. Jan. 13, 2022).  In doing so, the District Court questioned the opt-out mechanism used for the releases, determining that they were not consensual, and found that the debtors failed to satisfy Fourth Circuit precedent for approval of non-consensual third party releases, which should only be approved “cautiously and infrequently.” See Id. at *24. 

In contrast, the United States Bankruptcy Court for the District of Delaware recently issued a ruling that recognized nonconsensual third-party releases are permissible under the law of the Third Circuit.  See In Re Mallinckrodt PLC, et al., 2022 WL 334245, at *14 (Bankr. D. Del. Feb. 3, 2022).

While courts have taken different positions on nonconsensual third-party releases, the NRPA proposes to resolve this discord by adding a new section 113 to the Bankruptcy Code that would provide for a general prohibition on nonconsensual third-party releases across all jurisdictions. 

Proposed Prohibition on Non-Debtor Releases

Under the NRPA, new section 113 would stipulate that a court may not:

• approve any provision in a chapter 11 plan that provides for the discharge, release, termination, or modification of a non-debtor liability or order the discharge, release, termination, or modification of a non-debtor liability; or
• enjoin the commencement or continuation of a judicial, administrative, or other action or proceeding to assert, assess, collect, recover, offset, recoup, or otherwise enforce a non-debtor claim or cause of action against a non-debtor entity or non-debtor property, or enjoin any act to assert, assess, collect, recover, offset, recoup, or otherwise enforce such claim or cause of action.

In other words, the NRPA proposes to make clear that bankruptcy courts do not have authority to approve nonconsensual releases of non-debtor third parties, except as currently provided in section 524(g) of the Bankruptcy Code with respect to asbestos claims. 

Of note, the NRPA not only prohibits nonconsensual third-party releases but also seeks to clarify what constitutes consent for such releases – specifically requiring written consent signed by the releasing party and mandating that silence would not be sufficient to evidence consent.  The NRPA expressly stipulates that consent may not be given by (i) accepting a proposed plan, (ii) failing to reject a proposed plan, (iii) any other silence or inaction, or (iv) providing for treatment more or less favorable to a nondebtor claimholder for consenting or failing to consent.

This proposed written requirement would do away with decisions by certain courts that have found that a claimholder consents in the following circumstances: (i) where holders of impaired claims whose votes are solicited but do not vote or opt out of or otherwise object to the releases, (ii) where holders of impaired claims vote to reject the plan but do not opt out of or otherwise object to the releases, and (iii) where holders of impaired claims are deemed to reject the plan but do not opt out of or otherwise object to the releases.

Proposed 90-Day Limit on Extension of Automatic Stay To Non-Debtors

As discussed here and here, bankruptcy courts have routinely relied upon section 105(a) of the Bankruptcy Code to extend the protections of the automatic stay provided under section 362 of the Bankruptcy Code to non-debtors in “unusual circumstances” or when a claim against the non-debtor will have an “immediate adverse economic consequence for the debtor’s estate” or where an action against the third party could impact the debtor’s reorganization. 

The NRPA proposes to place a temporal restriction on this practice absent consent of the applicable party in interest.  Specifically, the NRPA proposes that, in a chapter 11 case, no order or decree temporarily staying or enjoining an action against a non-debtor entity (or against property of a non-debtor entity) may extend (or be extended) beyond 90 days after the date such order is issued without the express consent of the entity whose claim or cause of action is stayed or adjourned.

Furthermore, the NRPA provides that the appropriate court of appeals would have jurisdiction of appeals from all orders and decrees (whether interlocutory or final) temporarily staying or enjoining non-debtor causes of action entered in a chapter 11 case.  The stay order, however, would immediately terminate and be of no further effect after 90 days of its issuance unless the appeal is dismissed or the court of appeals affirms the stay order before that date.

Proposed Dismissal for Divisional Merger Chapter 11 Cases

In recent years, several companies facing asbestos liabilities have implemented divisional mergers under Texas law, followed by a chapter 11 filing for the new entity holding the asbestos liability (sometimes referred to as a “Texas Two-Step”).  In a typical divisional merger, the company with the tort liabilities divides into two separate companies – one that holds most of the company’s assets and one that is responsible for the company’s legacy liabilities.

In response to these recent cases, the NRPA proposes to amend the Bankruptcy Code such that, upon the request of a party in interest and after notice and a hearing, a bankruptcy court would be required to dismiss a chapter 11 case if the debtor or a predecessor of the debtor was the subject of a divisional merger or equivalent transaction or restructuring that (i) had the intent or foreseeable effect of (A) separating material assets from material liabilities and (B) assigning or allocating all or a substantial portion of those liabilities to the debtor or the debtor assuming or retaining all or a substantial portion of those liabilities and (ii) occurred during the 10-year period preceding the chapter 11 filing date.  Accordingly, if enacted, the NRPA could take away a company’s ability to commence a case under the Bankruptcy Code if the company was the subject of a divisional merger within 10 years prior to the filing date.

Bankruptcy Venue Reform Act of 2021

Overview

On June 28, 2021, Representatives Zoe Lofgren (D-Calif.) and Ken Buck (R-Colo.) introduced the BVRA in the House of Representatives, and on September 23, 2021, Senator Elizabeth Warren (D-Mass.) and John Cornyn (R-Texas) introduced an equivalent bill in the Senate.  The BVRA is the latest in a long line of unsuccessful bipartisan attempts to limit purported “forum-shopping” in bankruptcy cases.  As of the date of this Article, neither the Senate Judiciary Committee nor the House Judiciary Committee has yet to consider the BVRA.

The BVRA proposes to amend the Judicial Code to, among other things, (i) require corporate debtors to file for bankruptcy in the district where their principal assets or principal place of business in the United States is located (with the presumption that the principal place of business of a public company is the address listed on its SEC filing), (ii) prohibit corporate debtors from filing in a district simply on the basis of their state of formation, (iii) stop debtors from filing for bankruptcy in another district simply because an affiliate of the debtor has filed there (unless the affiliate is the parent), and (iv) upon objection, place the burden on the debtor to establish that venue is proper by clear and convincing evidence.

Venue Statute (Section 1408 of the Judicial Code)

Section 1408 of the Judicial Code governs venue for chapter 11 cases.  Currently, under section 1408, venue is proper in any district where the debtor (i) is domiciled, (ii) resides, (iii) has its principal place of business, or (iv) has its principal assets located, in each case for the 180 days preceding the chapter 11 filing, or in which there is pending a case under the Bankruptcy Code concerning such person’s affiliate, general partner, or partnership.  See 28 U.S.C. § 1408(1). 

• Domicile: Bankruptcy courts generally find that a debtor’s state of incorporation or organization, as applicable, is its domicile. 
• Principal Place of Business: The location of a debtor’s principal place of business takes into consideration all relevant facts and circumstances.  Courts often employ the “major business decisions test” or the “nerve center test,” which focuses on where the debtor’s most important or consequential business decisions are made.  Accordingly, principal place of business is best read as referring to the place where a corporation’s officers direct, control, and coordinate the corporation’s activities and not simply where a corporation holds its board meetings.
• Principal Assets: Courts generally undertake a fact-specific analysis to determine whether assets located within the selected district are sufficient to establish venue.  Assets may include, for example, the debtor’s accounts receivable and bank accounts.  Certain courts have found that a debtor cannot ground venue merely by having assets in a particular jurisdiction when it has greater or more important assets in other districts. 

The BVRA proposes to revise Section 1408 of the Judicial Code to provide that a chapter 11 case may be commenced only –

• in the district in which the debtor’s principal place of business or principal assets in the United States have been located –
  • for the 180 days immediately preceding commencement of the chapter 11 case; or
  • for a longer portion of the 180-day period immediately preceding the commencement of the chapter 11 case than the domicile, residence, or principal assets in the United States were located in any other district; or
• in which there is a pending chapter 11 case concerning an affiliate that directly or indirectly owns, controls, or holds more than 50% or more of the outstanding voting securities of, or is the general partner of, the entity that is the subject of the later filed chapter 11 case, but only if the pending chapter 11 case was properly filed in that district in accordance with the foregoing provisions.

Accordingly, if the BVRA is enacted, a debtor would not be permitted to commence a chapter 11 case in a district based solely on its domicile or a pending case being commenced in a district by an affiliate of the debtor unless the affiliate is the debtor’s controlling shareholder.

Proposed Limitations on Changes in Ownership or Control

The BVRA also proposes that for the purposes of venue, no effect will be given to certain changes or transactions that take place (i) within one year before the commencement of the chapter 11 case or (ii) for the purpose of establishing venue (in whole or in part).  These include (x) a change in the ownership or control of an entity that is the subject of the chapter 11 case, or of an affiliate of the entity, or (y) a transfer to another district of the principal place of business or principal assets, or the merger, dissolution, spinoff, or divisional merger of an entity that is the subject of the chapter 11 case, or of an affiliate of the entity.

Accordingly, if the BVRA is enacted, companies would be restricted from filing chapter 11 cases in a jurisdiction if the debtor took some action to establish venue in that jurisdiction (such as a transfer of principal place of business or reincorporation) within one year prior to filing or if such action was taken for the purpose of establishing venue.  Furthermore, the recent practice in some divisional merger chapter 11 cases of incorporating the debtor-entity in the jurisdiction of choice immediately preceding the debtor entity’s chapter 11 filing may no longer be a feasible option.

Proposed Definition of “Principal Assets”

If the BVRA is enacted, the Judicial Code would explicitly provide that the term “principal assets” does not include cash or cash equivalents.  Moreover, the BVRA provides that any equity interest in an affiliate is located in the district in which the holder of the equity interest has its principal place of business in the United States, as opposed to the state of formation.

Venue Transfer (Section 1412 of the Judicial Code)

Currently, notwithstanding that a case or proceeding under the Bankruptcy Code is filed in the correct division or district, venue for a chapter 11 case may be transferred by the bankruptcy court on its own accord or upon motion (i) in the interest of justice or (ii) for the convenience of the parties.  A movant seeking to transfer a bankruptcy case to a different venue bears the burden of proof, which must be carried by a preponderance of the evidence because a debtor’s choice of forum is entitled to great weight if venue is proper pursuant to section 1408.  Similar rules would apply under the BVRA if enacted.

Further, if the BVRA is enacted, the Judicial Code would be amended to provide that a case under the Bankruptcy Code filed in an improper division or district should be (i) immediately dismissed or (ii) if it is in the interest of justice, immediately transferred to any district court for any district or division in which the case or proceeding could have been brought.

Proposed 14-Day Rule on Objections and Requests Relating to Changes in Venue

The BVRA provides that the court should enter an order granting or denying an objection to, or a request to change, venue of a case or proceeding under the Bankruptcy Code, or arising in or related to a case under the Bankruptcy Court, not later than 14 days after it is filed.

Changes to Judge Assignment Protocols for Mega Chapter 11 Cases

Southern District of New York

As of December 1, 2021, mega chapter 11 cases filed in the Southern District of New York (which includes cases filed in Manhattan, Poughkeepsie and White Plains) will be randomly assigned to one of the bankruptcy judges of the district without regard to the courthouse in which the case is filed.  A chapter 11 case qualifies as a “mega” case if the assets or liabilities of the debtor (or on a cumulative basis for multiple debtors) are at least $100 million. 

In its November 22, 2021 press release, the United States Bankruptcy Court for the Southern District of New York indicated that the new judge assignment protocol of mega chapter 11 cases would result in a more balanced utilization of judicial resources. 

Eastern District of Virginia

Starting February 15, 2022, mega chapter 11 cases filed in the Eastern District of Virginia (which includes cases filed in Alexandria, Norfolk, Newport News, and Richmond) will be randomly assigned to one of the bankruptcy judges of the district without regard to the division in which the case is filed.  Additionally, all bankruptcy judges in the district will be eligible to be assigned to a mega chapter 11 case with the exception of the Chief Judge.  A chapter 11 case qualifies as a “mega” case in the Eastern District of Virginia if the assets or liabilities of the debtor (or on a cumulative basis for multiple debtors) are greater than $100 million. 

Conclusion

If the NRPA and BVRA are enacted, controversial issues in corporate restructuring practice that have garnered significant congressional and media attention will be substantially altered.  The debate remains, however, as to whether the issues discussed in this Article should be left to the courts to police rather than to Congress and whether blanket legislation, such as the NRPA and BVRA, may have broad and unintended consequences.