Texas District Court: Equitable Mootness Doctrine Does Not Preclude Appellate Review of Chapter 11 Plan Exculpation Clause

Exculpation clauses limiting the liability of certain entities for actions taken in connection with a bankruptcy case are a common feature of chapter 11 plans. However, courts disagree over the permitted scope of such clauses. They also disagree as to whether an order confirming a chapter 11 plan that includes exculpation and third-party release provisions is insulated from appellate review under the doctrine of "equitable mootness."

The U.S. District Court for the Southern District of Texas addressed both of these questions in Bouchard v. Bouchard Transportation Co. (In re Bouchard Transportation Co.), 2023 WL 1797907 (S.D. Tex. Feb. 7, 2023). The district court reversed and remanded a bankruptcy court order confirming a chapter 11 plan that included an overbroad exculpation provision, even though the order was not stayed pending appeal, the plan had been substantially consummated, and the plan included a nonseverability provision precluding removal or modification of the exculpation provision. Based on Fifth Circuit precedent, the district court held that, to safeguard the integrity of the chapter 11 process, the doctrine of equitable mootness cannot bar appellate review of an order confirming a plan that contains an impermissibly broad exculpation provision.

Validity of Third-Party Releases and Exculpation Clauses

Section 524(e) of the Bankruptcy Code provides that, "[e]xcept as provided in subsection (a)(3) of this section [making the discharge injunction applicable to actions to collect against community property], discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt." Even so, chapter 11 plans confirmed by bankruptcy courts in certain circuits commonly include provisions that either release or exculpate various non-debtors from certain liabilities.

Such releases can provide for the relinquishment of both prepetition and postpetition claims belonging to the debtor or non-debtor third parties (e.g., creditors or shareholders) against various non-debtors.

Exculpation clauses, by contrast, typically specify the scope of, or the standard of care (e.g., ordinary negligence, gross negligence, or willful misconduct) governing, an exculpated party's liability for conduct during the course of the bankruptcy case. See In re Aegean Marine Petroleum Network Inc., 599 B.R. 717, 721 (Bankr. S.D.N.Y. 2019) (noting that "an appropriate exculpation provision should say that it bars claims against the exculpated parties based on the negotiation, execution, and implementation of agreements and transactions that were approved by the Court"); In re Murray Metallurgical Coal Holdings, LLC, 623 B.R. 444, 501 (Bankr. S.D. Ohio 2021); see also Blixseth v. Credit Suisse, 961 F.3d 1074, 1084 (9th Cir. 2020) (distinguishing releases and exculpation clauses), cert. denied, 141 S.Ct. 1394 (2021). Exculpation clauses typically insulate estate fiduciaries, including officers, directors, and employees of the debtors and the reorganized debtors, as well as advisers and professionals retained by the estate, from most claims arising from their conduct during the chapter 11 case. See, e.g., In re PWS Holding Corp., 228 F.3d 224, 246 (3d Cir. 2000).

Although it is generally accepted that a chapter 11 plan can release non-debtors from claims of other non-debtor third parties if the release is consensual, courts disagree over whether a bankruptcy court has the authority—either constitutionally or under the Bankruptcy Code—to approve such releases over the objections of creditors or other stakeholders as part of a chapter 11 plan in a non-asbestos bankruptcy case. See 11 U.S.C. § 524(g) (providing for the creation of a trust to fund the payment of claims and the issuance of a channeling injunction in asbestos chapter 11 cases); see generally Collier on Bankruptcy ¶ 524.05 (16th ed. 2023) (discussing cases and noting that "Courts have disagreed over whether section 524(e) prohibits a provision of a confirmed plan under chapter 11 or under any of the other rehabilitation chapters that provides for releases for third parties (that is, parties other than the debtor)").

The circuit courts of appeals disagree over whether nonconsensual third-party releases and exculpation provisions are barred by section 524(e). The minority view, held by the Fifth and Tenth Circuits, is that such provisions are categorically precluded by section 524(e) absent express authority in another provision of the Bankruptcy Code (e.g., 11 U.S.C. § 1103(c), which has been interpreted to limit the liability of members of official committees to liability for willful misconduct or ultra vires acts). See Bank of N.Y. Trust Co. v. Official Unsecured Creditors' Comm. (In re Pacific Lumber Co.), 584 F.3d 229 (5th Cir. 2009); Landsing Diversified Props. v. First Nat'l Bank & Tr. Co. of Tulsa (In re W. Real Estate Fund, Inc.), 922 F.2d 592 (10th Cir. 1990). By contrast, the Second, Third, Fourth, Sixth, Seventh, Ninth, and Eleventh Circuits read section 524(e) to allow varying degrees of limited third-party releases and exculpations. See In re Metromedia Fiber Network, Inc., 416 F.3d 136, 143 (2d Cir. 2005); PWS Holding, 228 F.3d at 245–46; In re A.H. Robins Co., 880 F.2d 694, 702 (4th Cir. 1989); In re Dow Corning Corp., 280 F.3d 648, 658 (6th Cir. 2002); In re Airadigm Commc'ns., Inc., 519 F.3d 640, 657 (7th Cir. 2008); Blixseth, 961 F.3d at 1084; In re Seaside Eng'g & Surveying, Inc., 780 F.3d 1070, 1078 (11th Cir. 2015).

In Blixseth, the Ninth Circuit held that nothing in the Bankruptcy Code—including section 524(e)—precludes plan exculpation clauses, and that such clauses may be approved under sections 105(a), which gives a bankruptcy court the power to "issue any order, process, or judgment necessary or appropriate to carry out the provisions of [the Bankruptcy Code]," and 1123(b)(6), which provides that a chapter 11 plan may "include any other appropriate provision not inconsistent with the applicable provisions of [the Bankruptcy Code]."

In so ruling, the court wrote:

Section 524(e) establishes that "discharge of a debt of the debtor does not affect the liability of any other entity on … such debt." … In other words, "the discharge in no way affects the liability of any other entity … for the discharged debt."… By its terms, § 524(e) prevents a bankruptcy court from extinguishing claims of creditors against non-debtors over the very debt discharged through the bankruptcy proceedings.

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A bankruptcy discharge thus protects the debtor from efforts to collect the debtor's discharged debt indirectly and outside of the bankruptcy proceedings; it does not, however, absolve a non-debtor's liabilities for that same "such" debt.

Blixseth, 961 F.3d at 1082–83 (citations omitted); accord PWS Holding, 228 F.3d at 245–46.

Equitable Mootness

"Mootness" is a doctrine that precludes a reviewing court from reaching the underlying merits of a controversy. An appeal can be either constitutionally, statutorily, or equitably moot. Constitutional mootness is derived from Article III of the U.S. Constitution, which limits the jurisdiction of federal courts to actual cases or controversies and, in furtherance of the goal of conserving judicial resources, precludes adjudication of cases that are hypothetical or merely advisory.

An appeal can also be rendered moot (or otherwise foreclosed) by statute. For example, section 363(m) of the Bankruptcy Code provides that, absent a stay pending appeal, "[t]he reversal or modification on appeal of an authorization … of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith."

The court-fashioned remedy of "equitable mootness" bars adjudication of an appeal when a comprehensive change of circumstances has occurred such that it would be inequitable for a reviewing court to address the merits of the appeal. In bankruptcy cases, appellees often invoke equitable mootness as a basis for precluding appellate review of an order confirming a chapter 11 plan.

The doctrine of equitable mootness is sometimes criticized as an abrogation of federal courts' "virtually unflagging obligation" to hear appeals within their jurisdiction. See In re One2One Commc'ns, LLC, 805 F.3d 428, 433 (3d Cir. 2015); In re Charter Commc'ns, Inc., 691 F.3d 476, 481 (2d Cir. 2012). According to this view, dismissing an appeal on equitable mootness grounds "should be the rare exception." In re Tribune Media Co., 799 F.3d 272, 288 (3d Cir. 2015); accord Pacific Lumber, 584 F.3d at 240 (equitable mootness should be applied "with a scalpel rather than an axe").

Substantially similar tests have been applied by most circuit courts in assessing whether an appeal of a chapter 11 confirmation order should be dismissed under equitable mootness. Those tests generally focus on whether the appellate court can fashion effective and equitable relief. See, e.g., PPUC Pa. Pub. Util. Comm'n v. Gangi, 874 F.3d 33, 37 (1st Cir. 2017) (considering whether: (i) the appellant diligently pursued all available remedies to obtain a stay of the confirmation order; (ii) the challenged chapter 11 plan had progressed "to a point well beyond any practicable appellate annulment"; and (iii) providing relief would harm innocent third parties); JPMCC 2007-C1 Grasslawn Lodging, LLC v. Transwest Resort Props., Inc. (In re Transwest Resort Props., Inc.), 801 F.3d 1161, 1167–68 (9th Cir. 2015) (applying a four-factor test, including whether the court "can fashion effective and equitable relief without completely knocking the props out from under the plan and thereby creating an uncontrollable situation for the bankruptcy court"); In re Tribune Media Co., 799 F.3d 272, 278 (3d Cir. 2015) (considering: "(1) whether a confirmed plan has been substantially consummated; and (2) if so, whether granting the relief requested in the appeal will (a) fatally scramble the plan and/or (b) significantly harm third parties who have justifiably relied on plan confirmation"); Search Market Direct, Inc. v. Jubber (In re Paige), 584 F.3d 1327, 1339 (10th Cir. 2009) (applying a six-factor test, including the likely impact upon a successful reorganization of the debtor if the appellant's challenge is successful); In re United Producers, Inc., 526 F.3d 942, 947–48 (6th Cir. 2008) (three-factor test); TNB Fin., Inc. v. James F. Parker Interests (In re Grimland, Inc.), 243 F.3d 228, 231 (5th Cir. 2001) (same); see also In re Fin. Oversight & Mgmt. Bd. for Puerto Rico, 2021 WL 438891, **6-7 (1st Cir. Feb. 8, 2021) (holding that the doctrine of equitable mootness was not abrogated by the U.S. Supreme Court's ruling in Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019), and that the doctrine applied to dismiss an appeal of an order approving a plan in a proceeding under the Puerto Rico Oversight, Management, and Economic Stability Act).

A common element of almost all of these tests is whether the chapter 11 plan has been substantially consummated. Section 1101(2) of the Bankruptcy Code provides that "substantial consummation" of a chapter 11 plan occurs when substantially all property transfers proposed by the plan have been completed, the debtor or its successor has assumed control of the debtor's business and property, and plan distributions have commenced.

Equitable Mootness as a Bar to Appellate Review of Exculpation Provisions?

In Pacific Lumber, the Fifth Circuit held that the doctrine of equitable mootness did not preclude appellate review of an unstayed order confirming a substantially consummated chapter 11 plan that contained third-party releases and exculpation clauses. In so ruling, the Fifth Circuit stated as follows:

In short, the goal of finality sought in equitable mootness analysis does not outweigh a court's duty to protect the integrity of the process. We see little equitable about protecting the released non-debtors from negligence suits arising out of the reorganization. In a variety of contexts, this court has held that Section 524(e) only releases the debtor, not co-liable third parties…. These cases seem broadly to foreclose non-consensual non-debtor releases and permanent injunctions.

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There are no allegations in this record that [the third parties] were jointly liable for any of [the debtors'] pre-petition debt. They are not guarantors or sureties, nor are they insurers. Instead, the essential function of the exculpation clause proposed here is to absolve the released parties from any negligent conduct that occurred during the course of the bankruptcy. The fresh start § 524(e) provides to debtors is not intended to serve this purpose.

Pacific Lumber, 584 F.3d at 252–53 (citations and footnote omitted).

The Fifth Circuit revisited the issue in NexPoint Advisors L.P. v. Highland Capital Management, 48 F.4th 419 (5th Cir. 2022), petition for cert. filed, No. 22-631 (U.S. Jan. 5, 2023), on remand, 2023 WL 2250145 (Bankr. N.D. Tex. Feb. 27, 2023). The court of appeals held that: (i) although the Fifth Circuit categorically bars non-debtor releases, a chapter 11 plan may give the bankruptcy court a "gatekeeper" function to approve or disapprove litigation against entities that would be protected by exculpations in other circuits; and (ii) overbroad exculpations and non-debtor releases cannot escape appellate review under the doctrine of equitable mootness even if the chapter 11 plan containing such releases and exculpations has been substantially consummated and the party challenging the provisions failed to obtain a stay pending appeal of the plan confirmation order. Id. at 439-40.

In so ruling, the Fifth Circuit wrote that "equity strongly supports appellate review of issues consequential to the integrity and transparency of the Chapter 11 process" and "the goal of finality sought in equitable mootness analysis does not outweigh a court's duty to protect the integrity of the process." Id. at 431 (quoting Pacific Lumber, 584 F.3d at 252).

The Fifth Circuit rejected arguments that exculpations could be authorized under sections 105(a) and 1123(b)(6) of the Bankruptcy Code. According to the court, "in this circuit, § 105(a) provides no statutory basis for a nondebtor exculpation … [a]nd the same logic extends to § 1123(b)(6)." Id. at 437.

The Fifth Circuit acknowledged the circuit split as to whether third parties may be exculpated, but emphasized that "[the Fifth Circuit] along with the Tenth Circuit hold § 524(e) categorically bars third-party exculpations absent express authority in another provision of the Bankruptcy Code." The Fifth Circuit then ruled that the exculpation provision before it could extend only to the debtor and related entities, the unsecured creditors' committee and its members, and the debtor's independent directors "for conduct within the scope of their duties." Id. at 438.

On remand, the bankruptcy court granted the debtor's motion to alter the exculpation provisions in its chapter 11 plan in accordance with the Fifth Circuit's decision. 

Other courts have similarly concluded that the doctrine of equitable mootness should not prevent appellate review of chapter 11 plan release or exculpation provisions under certain circumstances. See, e.g., PWS Holding, 228 F.3d at 236 (ruling that an appeal of an order confirming a substantially consummated chapter 11 plan was not equitably moot because at least some of the plan's release and exculpation provisions could be removed without threatening the success of the reorganization). But see In re Millennium Lab Holdings II, LLC., 945 F.3d 126, 144 (3d Cir. 2019) (equitable mootness barred appellate review of plan confirmation order where removal of challenged releases would "fatally scramble the plan and/or harm third parties").

Bouchard

Bouchard Transportation Co., Inc. ("BTC") and its affiliates (collectively, the "debtors") provided oil and petroleum transportation services in the United States. In September 2020, the financial impact of the pandemic forced the debtors to file for chapter 11 protection in the Southern District of Texas.

BTC's CEO, Morton Bouchard, had loaned the company more than $40 million before the bankruptcy filing. He continued to serve as CEO and sole officer of BTC during the first five months of the chapter 11 case but was supplanted in that role by a chief restructuring officer in February 2021 after the bankruptcy court found that Bouchard had impeded the chapter 11 process.

The debtors filed a proposed chapter 11 plan in August 2021. The plan provided that the debtors, the plan administrator, the post-effective date debtor, the creditors' committee, each member of the creditor's committee, and various related entities (including certain unnamed trustees) were:

released and exculpated from any Cause of Action for any claim related to any act or omission in connection with, relating to, or arising out of, the formulation, preparation, dissemination, negotiation, entry into, or filing of, as applicable, the Chapter 11 Cases, the Disclosure Statement, the Plan … or any Plan Transaction, contract, instrument, release, or other agreement or document created or entered into in connection with the Disclosure Statement or the Plan, the filing of the Chapter 11 Cases, the pursuit of Confirmation, the pursuit of Consummation, the administration and implementation of the Plan, including the distribution of property under the Plan or any other related act or omission, transaction, agreement, event, or other occurrence taking place on or before the Case Effective Date … , except for claims related to any act or omission that is determined in a Final Order of a court of competent jurisdiction to have constituted actual fraud, willful misconduct, or gross negligence, but in all respects such Entities shall be entitled to reasonably rely upon the advice of counsel with respect to their duties and responsibilities pursuant to the Plan.

The plan also included an injunction to enforce the exculpation provision by prohibiting litigation against the exculpated parties.

Finally, the plan included a nonseverability clause, which provided in relevant part as follows:

Except as set forth in Article X of the Plan, the provisions of the Plan, including its release, injunction, exculpation and compromise provisions, are mutually dependent and non-severable. The Confirmation Order shall constitute a judicial determination and shall provide that each term and provision of the Plan is: (1) valid and enforceable pursuant to its terms; (2) integral to the Plan and may not be deleted or modified without the consent of the Debtors; and (3) non-severable and mutually dependent ….

Bouchard objected to the plan's exculpation provision and related injunction, arguing that the exculpation clause was too broad and should be limited to the debtors, the creditors' committee and its members, and the unnamed trustees, for conduct within the scope of their duties in the bankruptcy, rather than including non-debtors and other third parties and entities.

The bankruptcy court confirmed the debtors' plan over Bouchard's objections. Bouchard appealed the confirmation order to the U.S. District Court for the Northern District of Texas. He did not seek a stay of the plan confirmation order, and the debtors' plan was substantially consummated before the district court could rule on the appeal. 

On appeal, the debtors argued that the appeal was equitably moot due to substantial consummation of the plan and the plan's nonseverability provision. Bouchard argued to the contrary, claiming that, notwithstanding the plan's nonseverability provision, the overbroad exculpation clause should be modified.

The District Court's Ruling

The district court ruled that: (i) the doctrine of equitable mootness did not preclude appellate review and modification of the exculpation clause; and (ii) the exculpation clause was overbroad under governing Fifth Circuit law.

Initially, U.S. District Court Judge Lee H. Rosenthal explained that Bouchard's failure to obtain a stay pending appeal and substantial consummation of the plan favored the debtors' argument that the appeal was equitably moot.

However, Judge Rosenthal noted, the Fifth Circuit's decisions in both Pacific Lumber and Highland—which was handed down after Bouchard filed his appeal—strongly supported Bouchard's argument that the order confirming the debtors' plan was not insulated under the doctrine of equitable mootness from an appellate challenge to the allegedly overbroad scope of the plan's exculpation provision.

Evaluating the exculpation provision on the merits, Judge Rosenthal noted that the Fifth Circuit in Highland rejected the same arguments that the debtors made in this case regarding sections 105(a) and 1123(b)(6) as authority for the plan's exculpation provisions.

Judge Rosenthal also rejected the debtor's contention that "this appeal remains equitably moot in light of the Non-Severability Provision in the Plan here, which distinguishes this case from both Highland and Pacific Lumber." First, the judge explained, although neither decision noted the existence of a nonseverability provision in the plans under consideration, the publicly available record in Highland revealed that the plan confirmed in that case contained such a provision. Second, Judge Rosenthal emphasized, despite disagreement among other circuits on this point, "Highland drew a bright-line rule: 'In sum, [Fifth Circuit precedent and § 524(e) require an exculpation in a Chapter 11 reorganization plan be limited to the debtor, the creditors' committee and its members for conduct within the scope of their duties and the trustees within the scope of their duties.'" Bouchard, 2023 WL 1797907, at *3 (quoting Highland, 48 F.4th at 438). 

The district court accordingly reversed the plan confirmation order to the extent that it approved the overly broad exculpation and injunction provisions and remanded the case to the bankruptcy court with instructions to modify the plan. 

Outlook

In accordance with Highland and Pacific Lumber, the district court in Bouchard reaffirmed that an order confirming a chapter 11 plan that includes an allegedly overbroad exculpation provision cannot escape appellate review under the doctrine of equitable mootness, even if the plan includes a nonseverability clause prohibiting removal or modification of the provision. According to the district court, Fifth Circuit precedent dictates that the finality sought by applying equitable mootness to bar appellate review of substantially consummated plans does not trump a court's obligation to safeguard the integrity of the process. In addition, although it did not state as much in its opinion, the bankruptcy court appeared to take the view that modification of the exculpation provision would unravel neither the debtors' plan nor their prospects for a successful reorganization. 

The U.S. Supreme Court may weigh in on this issue later this year in Highland. Until then, Bouchard illustrates that the particular approach on equitable mootness adopted by the bankruptcy and appellate courts in every circuit may significantly affect the outcome of plan confirmation appeals.

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