Terraform Bankruptcy Protections Draw Justice Department Rebuke

Terraform Labs Pte.'s liquidation plan contains expansive liability protections that exceed the limits of bankruptcy law, the Justice Department’s bankruptcy watchdog said.

Under Third Circuit precedent, parties that receive liability releases need to make a substantial contribution to the debtor’s bankruptcy plan, the US Trustee said. But Terraform’s plan releases people in positions that won’t even exist until after its bankruptcy plan becomes effective, including a plan administrator and a wind down trustee.

Unless the US Bankruptcy Court for the District of Delaware determines those parties made a substantial contribution, the proposed releases can’t be approved as part of the plan, the US Trustee said in a Thursday objection.

Terraform, a fallen digital asset firm, filed Chapter 11 in January after saying it couldn’t pay penalties sought by federal regulators. In June, it agreed to pay $4.47 billion to resolve a US Securities and Exchange Commission lawsuit over the firm’s 2022 collapse.

The plan’s exculpation provisions, which provide liability protections for people who worked on the bankruptcy, are also overly broad because they cover an advisory board that won’t be formed until after the plan’s effective date, according to the objection. The Third Circuit has held that exculpation provisions can only cover conduct during bankruptcy, the US Trustee said.

“The Plan’s definition of Exculpated Parties is inconsistent with controlling case law because it is not limited to estate fiduciaries,” the US Trustee, which frequently objects to liability protection provisions in bankruptcy plans, said.

Further, Terraform itself acknowledged that it isn’t entitled to a discharge barring debt collections, and discharges aren’t permitted in liquidation plans, the US Trustee said. But Terraform’s plan contains an injunction that would act as an impermissible discharge, according to the objection.

“The Debtors should not be able to achieve something that is expressly prohibited,” the trustee said.

Lawyers for Terraform didn’t immediately respond to a request for comment.

Terraform is represented by Weil, Gotshal & Manges LLP and Richards Layton & Finger PA.

The case is Terraform Labs Pte. Ltd, Bankr. D. Del., No. 24-10070, 9/12/24.