Ex culpa or mea culpa: The use of exculpation provisions
in bankruptcy plans
By John B. Butler III
“Exculpated party” — while it does not seem like a salubrious appellation to which many would aspire, and in fact sounds menacingly painful — such is not the case. From the increasing number of cases dealing with “exculpation provisions” in Chapter 11 plans, it is obvious many parties in bankruptcy cases fervently desire to be exculpated.
Though similar to a non-debtor, thirdparty release, an exculpation provision is a more limited release of liability of certain non-debtor parties (usually professionals, employees or committees) who participated in the bankruptcy case. An exculpation provision only addresses liability for actions taken in connection with the bankruptcy case and does not attempt to release the exculpated parties from non-bankruptcy acts taken before or after the bankruptcy filing.
In a footnote to its National Heritage Foundation opinion, the 4th U.S. Circuit Court of Appeals clearly distinguished between the
third-party releases in the reorganization plan, which were not approved, and the exculpation provision, which was permissible, stating:
The plan also contained an exculpation provision, barring suits against the released parties for any acts or omissions in connection with the bankruptcy, and an injunction provision, enjoining suits in violation of either the release or exculpation provision. The Bankruptcy Court upheld the exculpation provision
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… a decision that neither party challenged. It also approved the injunction provision, but only to the extent that it enforced the exculpation provision and not the release provision. Based on our holding that the release provision is unenforceable, we find no error in that judgment.1
In explaining its reasons for approving, on remand, the exculpation provision but not the third-party releases, the Bankruptcy Court in National Heritage stated:
The exculpation provision is limited to acts or omissions taken in connection [with] the bankruptcy case itself. It does not purport to release any pre-petition claims against the officers or directors. Further, … there is a “gatekeeper” function built into Section 7.21 [of the debtor’s fourth amended plan], in that Section 7.21 expressly allows for suits against the released parties if the
claimant “obtains the prior approval of the Bankruptcy Court to bring such a claim.”
The court finds that the exculpation provision of Section 7.21: (a) is narrowly tailored to meet the needs of the bankruptcy estate; (b) is limited to parties who have performed necessary and valuable duties in connection with the case (excluding estate professionals); (c) is limited to acts and omissions taken in connection with the bankruptcy case; (d) does not purport
to release any pre-petition claims; and (e) contains a gatekeeper function by which the court may, in its discretion, permit an action to go forward against the exculpated parties. The court will not disturb the exculpation provisions of Section 7.21.2
Other courts have also approved exculpation provisions in Chapter 11 plans, even over the objections of parties, so long as the provisions were not too broad and were consistent with the standard of care expected of the released parties.
Though similar to a non-debtor, third-party release, an exculpation
provision is a more limited
release of liability of certain non-debtor parties.
For example, in In re PWS Holding Corp., the 3rd Circuit approved an exculpation provision protecting the officers, directors and employees of the debtors and the reorganized debtors, as well as advisers and professionals, in connection with the confirmation and consummation of the plan, so long as there was no willful misconduct or gross negligence.3
The District Court in In re South Edge LLC affirmed the Bankruptcy Court’s approval of an exculpation provision protecting officers, directors and employees of the debtors and the reorganized debtors, as well as advisers and professionals and lenders.4 The provision was in connection with the Chapter 11 case, the disclosure statement, the confirmed plan or any document entered into during the Chapter 11 case. The exculpation provision did not cover willful misconduct or gross negligence.
The court in In re Neogenix Oncology Inc. approved an exculpation clause that only covered post-petition actions by committee
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members and the debtor’s officers and directors who served during the case and excluded claims of gross negligence and willful misconduct.5
In In re Quincy Medical Center the Bankruptcy Court considered the objection of the U.S. Trustee to the scope of the exculpation clause and approved a modified clause that covered the indenture trustee, the bond owners, the “debtors, creditors’ committee, liquidation trustee and their representatives.”6
In the Chapter 9 case of In re Connector 2000 Association, the Bankruptcy Court approved a plan exculpation clause that covered the debtor and its “directors, officers, employees, managers, attorneys, affiliates, agents and professionals (including but not limited to their attorneys, financial advisers, investment bankers, accountants, solicitation agents and other professionals.”7
In the oft-cited case In re Yellowstone Mountain Club LLC, the court approved a broad exculpation provision that stated:
None of (a) the debtors or the reorganized debtors, (b) the committee, (c) the individual members of the committee in their capacities as such, (d) the DIP [debtor-in-possession] lender, any other lenders of (or participants in) the DIP loan and any agent thereof, (e) the current equity owners, (f) CrossHarbor Capital Partners and all affiliates thereof, (g) the acquirer, and (h) with respect to each of the foregoing persons, each of their respective directors, officers, employees, agents ... representatives, shareholders, partners, members, attorneys, investment bankers, restructuring consultants and financial advisers in their capacities as such (collectively, the “exculpated arties ”), shall have or incur any liability to any person for any act or omission in connection with … the Chapter 11 cases, the formulation, negotiation, implementation, confirmation or consummation of this plan, the disclosure statement, or any … document entered into during the
Chapter 11 cases or otherwise created in connection with this plan.8
The court excluded willful misconduct or gross negligence from the exculpation clause.
In light of the extensive negotiations between the parties and the overwhelming
4 | WESTLAW JOURNAL n BANKRUPTCYacceptance of the plan by the creditors, the court in In re Winn-Dixie Stores approved an exculpation provision enjoining any right of action against the “debtors, the reorganized debtors, their respective subsidiaries, the creditors committee, Wachovia, the indenture trustee, or any of their respective present or former members, officers, directors, employees, advisers, professionals, and agents for any matters related to the Chapter 11 case or the plan process except for acts and omissions which are the result of fraud, gross negligence, or willful misconduct.”9 clause must be limited to the fiduciaries who have served during the Chapter 11 proceeding: estate professionals, the committees and their members, and the debtors’ directors and officers.”11
While most exculpation provisions protect parties who are professionals or employees of the debtor or parties affiliated with a committee, some courts have permitted exculpation clauses to protect parties such as lenders, indenture trustees, bondholders and related property owners.12 One court disagreed and held it was impermissible to
Courts have approved exculpation provisions in Chapter 11 plans, even over the objections of parties, so long as the provisions were not too broad and were consistent with the standard of care expected of the released parties.
By way of comparison, the court in In re Washington Mutual Inc. refused to approve an overly broad exculpation clause, stating:
[T]he 3rd Circuit has held that a creditors’ committee, its members, and estate professionals may be exculpated under a plan for their actions in the bankruptcy case except for willful misconduct or gross negligence. The 3rd Circuit reasoned that such a provision merely stated the standard to which such estate fiduciaries were held in a Chapter 11 case. That fiduciary standard, however, applies only to estate fiduciaries. The debtors’ plan goes further and seeks to encompass all the released parties and their related persons. This is either duplicative of the releases granted by the debtors or third parties … or is an effort to extend those releases. Either way it is inappropriate. The exculpation extend the exculpation provisions beyond fiduciaries in the bankruptcy case.13
Most courts, often at the suggestion of the U.S. Trustee, draw the exculpatory line in the sand at releasing gross negligence, fraud or willful misconduct.14
While National Heritage and other cases addressing broad third-party releases and narrower exculpation provisions have approved exculpation provisions rather than broader releases, the drafter of such exculpation provisions would do well to keep in mind the following considerations: •
• Limit the exculpated parties to professionals, people affiliated with an official committee, employees and officers of the debtor.
If you are going to expand the exculpated parties beyond those listed above, include only additional parties that clearly provided financial and other consideration to the bankruptcy estate.
Limit the scope of the exculpation provisions to post-petition actions taken in connection with the bankruptcy case or particular aspects of the bankruptcy case, such as plan solicitation or plan implementation, and do not include any potential pre-petition claims in the scope of exculpated acts.
Include a gatekeeping procedure so parties wishing to bring an action covered by the exculpation provisions may file a motion in the bankruptcy
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court to be permitted to pursue the otherwise prohibited action.
- Submit evidence at the confirmation hearing which shows the protection is crucial in the plan negotiations and necessary for confirmation of the plan or continued operation of the reorganized debtor. WJ
1 Nat’l Heritage Found. v. Highbourne Found., 760 F.3d 344, n. 2. (4th Cir. 2014) (citation omitted).
2 In re Nat’l Heritage Found., 478 B.R. 216, 234 (Bankr. E.D. Va. 2012), aff’d sub nom. Nat’l Heritage Found. v. Highbourne Found., 760 F.3d 344 (citations omitted). See also, In re S. Edge LLC, 478 B.R. 403, 415-16 (D. Nev. 2012) (“In light of the above authorities, the exculpation provision in Section 8.10 when properly interpreted is within the bankruptcy court’s power because the bankruptcy court has exclusive jurisdiction over the parties and their conduct in the bankruptcy proceedings. Section 8.10 sets a standard of care to be applied in the bankruptcy proceeding — a matter which lies within the bankruptcy court’s exclusive jurisdiction — and reiterates federal preemption principles.”).
3 In re PWS Holding Corp., 228 F.3d 224 (3d Cir. 2000).
4 In re S. Edge, 478 B.R. 403.
5 In re Neogenix Oncology Inc., 508 B.R. 345, 362 (Bankr. D. Md. 2014).
6 In re Quincy Med. Ctr., 2011 WL 5592907
(Bankr. D. Mass. Nov. 16, 2011).
7 In re Connector 2000 Ass’n, 447 B.R. 752, 761 (Bankr. D.S.C. 2011).
8 In re Yellowstone Mountain Club, 460 B.R. 254, 266-67 (Bankr. D. Mont. 2011), aff’d sub nom. Sumpter v. Yellowstone Mountain Club LLC, 584 Fed. Appx. 676 (9th Cir. 2014).
9 In re Winn-Dixie Stores, 356 B.R. 239, 260-61 (Bankr. M.D. Fla. 2006).
10 In re WCI Cable Inc., 282 B.R. 457, 479-80 (Bankr. D. Or. 2002).
11 In re Wash. Mut. Inc., 442 B.R. 314, 350-51 (Bankr. D. Del. 2011) (citations omitted).
12 See In re S. Edge, 478 B.R. 403; In re Yellowstone Mountain, 460 B.R. 254; In re Quincy Med. Ctr., 2011 WL 5592907; In re Connector 2000, 447 B.R. 752; In re Winn-Dixie, 356 B.R. 239.
13 In re Wash. Mut.., 442 B.R. at 350-51 (“The exculpation clause must be limited to the fiduciaries who have served during the Chapter 11 proceeding: estate professionals, the committees and their members, and the debtors’ directors and officers.”).
14 In re PWS Holding, 228 F.3d 224; In re S. Edge, 478 B.R. 403; In re Neogenix, 508 B.R. 345; In re Wash. Mut., 442 B.R. 314; In re Yellowstone Mountain, 460 B.R. 254; In re Winn-Dixie, 356 B.R. 239; In re WCI Cable, 282 B.R. 457.
NEWS IN BRIEF