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Boy Scouts Bankruptcy Exposes Court Split on Liability Releases

Aug. 19, 2022, 9:00 AM

A recent decision allowing entities tied to the Boy Scouts of America to be released from sexual abuse claims has reignited debate over a controversial bankruptcy tactic and raised the stakes of an upcoming appellate court ruling involving Purdue Pharma LP.

Judge Laurie Selber Silverstein of the US Bankruptcy Court for the District of Delaware, in a long-awaited opinion released July 29, approved the bulk of the Boy Scouts’ intricate reorganization plan and $2.7 billion settlement with 82,000 adults who allege they were sexually abused in their youth as scouts.

Her ruling coincides with a question pending before the US Court of Appeals for the Second Circuit about whether a bankruptcy court has authority to approve nonconsensual liability releases in a case brought by Purdue Pharma.

The stark contrast in major cases that have grabbed national attention may ultimately lead to “a full out circuit split on the issue” that either Congress or the Supreme Court will have to resolve, said bankruptcy attorney Steven Smith of Herrick Feinstein LLP.

Third-party releases have been a feature of Chapter 11 reorganization plans for decades. But they have recently drawn more widespread attention because of their importance in “cases that are in the public eye,” said Arizona State University law professor Laura Coordes.

Other recent high-profile corporate Chapter 11 cases have been mired in heavy opposition to reorganization terms that shield debtors and other affiliated parties from future lawsuits.

No Explicit Ban

Silverstein’s 281-page opinion explained why insurance companies, a network of 250 local councils, and religious organizations that sponsored scouting activities can receive the same legal liability discharge as the Boy Scouts even though they never filed for bankruptcy. Alleged sexual abuse perpetrators aren’t being released from their liability.

The judge concluded that abuse victims can lose, without consent, their right to sue third parties that contribute to a mass settlement fund to pay them. The bankruptcy code “does not explicitly authorize releases, neither does it prohibit” such liability releases, Silverstein said.

Her holding is consistent with controlling caselaw in the US Court of Appeals for the Third Circuit, where Delaware sits. But it conflicts with a noteworthy New York federal court opinion from December rejecting similar releases in Purdue Pharma’s bankruptcy plan for the opioid manufacturer’s Sackler family owners.

“There’s this tension on the one hand with courts that find ways to approve those plans because there’s a hard fact that global peace is the way to solve contentious cases,” Smith said, referring to the settlements that were reached with the help of such releases. “But at the end of the day, there’s no bankruptcy code provision you can point to that allows it.”

Hot Topic

The bankruptcy code is silent on the liability release issue except in cases used to resolve asbestos-related tort liabilities. In such cases, the law expressly authorizes settlement trusts and channeling all claims against the debtor and other related parties to the trust.

Outside of asbestos-related cases, a scattershot of rulings have varied in permitting liability releases. Different federal circuits have developed different tests and standards to determine whether releases can be approved over a party’s opposition, with some saying the code prohibits them.

“There’s tension between the efficiency that proceedings in a bankruptcy court can give you and the right for every claimant to have their day in court,” said bankruptcy attorney Shai Schmidt of Glenn Agre Bergman & Fuentes LLP.

That tension has become more visible over the last three years with the Purdue Pharma and Boy Scouts bankruptcies. These debtors have been the focus of intense public outrage in the wake of the nation’s opioid crisis and the passage of state laws intended to address decades of institutional neglect of child sexual abuse.

“People who are following those cases are seeing what’s happening,” Coordes said. “There are so many parties to consider.”

These cases have also led Democrats in Congress to pursue legislation that would ban nonconsensual nondebtor release provisions in corporate bankruptcies.

Sackler Surprise

Last year, Judge Robert Drain of the US Bankruptcy Court for the Southern District of New York approved Purdue Pharma’s multibillion dollar proposal to settle thousands of lawsuits over its addictive opioid painkillers. In a controversial ruling, Drain said members of the Sackler family could be released from legal liability in exchange for a settlement contribution of nearly $4.5 billion.

But just three months later, Judge Colleen McMahon of the US District Court for the Southern District of New York reversed Drain’s decision, saying the bankruptcy court lacked authority to approve the releases.

In a ruling that sent shockwaves across corporate bankruptcy practitioners, McMahon said the question “has hovered over bankruptcy law for thirty-five years” and “should be put to rest now.”

That opinion has since been cited by a federal district judge who overturned the approval of third-party releases in the bankruptcy plan for Ascena Retail Group, former owner of several women’s fashion brands.

“We’re now waiting on the Second Circuit to opine,” said Smith.

Circuit Split

With scrutiny of third-party releases on the rise, the Boy Scouts ruling “seems to buck the growing trend” even though its “fairly consistent with the caselaw and authority” in the Third Circuit, Smith said.

Silverstein’s detailed ruling cites Third Circuit cases to conclude that “the granting of third-party releases is still permissible as part of the confirmation process.”

But the ruling also rejects Boy Scouts’ settlement reached with the Mormon church, a longtime partner of the Boy Scouts, saying it went “too far” by releasing abuse claims that arose outside of scouting activities.

Her findings reinforce the idea that releases “are not freely given, especially in cases like this where there are difficult facts,” Allen & Overy LLP bankruptcy attorney Dan Guyder said.

But “it could set the stage for more brinksmanship,” he said.

Approval of the Boy Scouts plan marks a definitive split from McMahon’s decision.

Continued divisions among the circuits on the issue will make “the Supreme Court’s attention more likely,” Coordes said

“You can see the differences there starting to percolate,” said Coordes.

To contact the reporter on this story: Alex Wolf in New York at awolf@bloomberglaw.com

To contact the editors responsible for this story: Maria Chutchian at mchutchian@bloombergindustry.com; Roger Yu at ryu@bloomberglaw.com