By Brian S. Hermann, Jacob A. Adlerstein, Claudia R. Tobler and Lindsay A. Wasserman (Paul, Weiss, Rifkind, Wharton & Garrison)
Chapter 11 plans commonly include exculpation clauses that protect a debtor’s key stakeholders that participate in the chapter 11 process from claims arising in connection with the bankruptcy case. Exculpation provisions are typically limited to key parties in the plan formulation process, such as the debtors, any official committee, certain lenders or security holders, and their related parties. They also exclude liabilities arising from gross negligence, fraud, and willful misconduct. Exculpation clauses have been challenged as impermissible under section 524(e) of the Bankruptcy Code. Section 524(e) of the Bankruptcy Code provides that, except for certain inapplicable exceptions, the “discharge of a debt . . . [in a chapter 11 proceeding] does not affect the liability of any other entity on . . . such debt.” In In re Pacific Lumber Co., 584 F.3d 229 (5th Cir. 2009), the Fifth Circuit Court of Appeals held that this section prohibits the effective release of claims against non-debtor exculpated parties.
In Nexpoint Advisors, L.P. v. Highland Capital Mgmt., L.P. (In re Highland Capital Management, L.P.), 48 F.4th 419 (5th Cir. 2022), the Fifth Circuit re-examined the scope of permissible exculpation under Pacific Lumber. It affirmed that the plan’s exculpation of the independent directors and creditors’ committee members was lawful because the Bankruptcy Code permits a limited qualified immunity to creditors’ committee members for actions within the scope of their statutory duties, and a similar qualified immunity to bankruptcy trustees unless they act with gross negligence.
The United States Bankruptcy Court for the Southern District of Texas recently held in In re Instant Brands Acquisition Holdings Inc., et al., Case No. 23-90716 that the Debtors’ chapter 11 plan properly exculpated the Debtors’ independent directors appointed prepetition for conduct performed within the scope of their duties during the administration of the chapter 11 cases, absent gross negligence or willful misconduct. The Bankruptcy Court found that the Fifth Circuit’s ruling in Highland Capital affirmed that the Bankruptcy Code authorizes exculpation of a bankruptcy trustee, and that these protections extend to a debtor-in-possession and its independent fiduciaries because the Bankruptcy Code vests a debtor-in-possession with all the authority of a bankruptcy trustee. The Bankruptcy Court rejected the U.S. Trustee’s attempts to narrow the Highland Capital ruling to its facts, in which the independent directors were appointed during the bankruptcy case by court order. It held that a “fair reading” of Highland Capital recognizes that the debtor’s fiduciaries may be afforded the same protections as the debtor regardless of when they are appointed. The decision affirms the inclusion of independent directors as exculpated parties even if they are appointed prepetition, notwithstanding the otherwise narrow scope of permitted exculpations in the Fifth Circuit. It remains to be seen, however, whether other parties may qualify as sufficiently “disinterested fiduciaries” to similarly benefit from such protections.
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