CSG Law Alert: Southern District of Texas Rejects Argument that Non-Severability Clause in Confirmation Order Renders Appeal of Overbroad Exculpation Clause Equitably Moot

Following the lead of some courts in other jurisdictions,1 the United States District Court for the Southern District of Texas recently held in In re Bouchard Transportation Co., Inc., BR 20-34682, 2023 WL 1797907 (S.D. Tex. Feb. 7, 2023) that a non-severability clause in a confirmation order does not render an appeal of an overbroad exculpation clause equitably moot.

In Bouchard, the appellants appealed to the district court from a bankruptcy court plan confirmation order that exculpated several non-debtor, third parties. The issues before the district court were: (1) whether the appellants’ objection to the exculpation clause in the confirmation order was equitably moot, and (2) if not, whether the exculpation clause was overly broad with respect to the third parties it released from liability.

Equitable mootness is a judge-made doctrine that arises in connection with appeals of bankruptcy court orders, most often appeals of orders confirming chapter 11 reorganization plans. The doctrine of equitable mootness provides that appeals of chapter 11 plans will be deemed moot, and not subject to appellate review, if a plan has been substantially consummated and granting appellate relief could upset a carefully balanced plan of reorganization upon which third parties have relied.

The Fifth Circuit considers three factors in determining whether equitable mootness should apply: (1) whether a stay has been obtained, (2) whether the plan has been substantially consummated, and (3) whether the relief requested would affect the rights of parties not before the court or the success of the plan. No one factor is dispositive.

In Bouchard, it was undisputed that a stay had not been obtained and that the plan had been substantially consummated. Nevertheless, the appellants argued that they should prevail under the third factor. The appellants relied heavily on In re Pacific Lumber, 584 F.3d 229 (5th Cir. 2009), which overturned an overbroad exculpation clause even though no stay had been obtained and the plan had been substantially consummated. In rejecting an equitable mootness argument in that case, the Fifth Circuit stated that “[e]quitable mootness should protect legitimate expectations of parties to bankruptcy cases but should not be a shield for sharp or unauthorized practices.” Id. at 244 n.19. In other words, debtors in bankruptcy should not be permitted to include unauthorized third-party releases in their plans of reorganization and then escape appellate review under the auspices of equitable mootness.

The appellants also relied on NexPoint Advisors, L.P. v. Highland Capital Management, 48 F.4th 419 (5th Cir. 2022), which dealt with similar challenges to an overbroad exculpation clause. Like the court in Pacific Lumber, in Highland the court also struck down an overbroad exculpation clause, notwithstanding that a stay had not been obtained and the plan was substantially consummated. The Fifth Circuit in Highland stated that “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.

The appellees attempted to distinguish Pacific Lumber and Highland on several grounds, including that neither the Pacific Lumber or Highland courts noted the existence of a non-severability clause in the plan of reorganization. The appellees argued that their plan, in contrast, contained a non-severability clause which stated, in pertinent part, that:

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 . . .

The appellees therefore argued that the exculpation provisions were not severable from the remainder of the plan.

The court, however, rejected this argument because a review of the docket revealed that the plan in Highland also included a non-severability clause and therefore there was no basis to distinguish Highland, which remained binding on the court.

With respect to the second issue, whether the exculpation clause at issue was overly broad, the court held that Fifth Circuit precedent firmly establishes a bright-line rule that the only parties permitted to be exculpated in a plan of reorganization are the debtor, the creditors’ committee and its members, and trustees within the scope of their duties. Therefore, the district court in Bouchard found that the exculpation clause in the confirmed plan was overbroad and struck the improper third-party releases.

For sureties involved in chapter 11 bankruptcies, the Bouchard case highlights the reviewability of overbroad exculpation and third-party releases under a plan of reorganization and reflects appellate courts’ willingness to strike those improper releases notwithstanding that a stay was not obtained and the plan has been substantially consummated. This may work for or against the surety depending upon whether the surety is a releasing or released party under the respective plan of reorganization, but in either circumstance it is an issue of which the surety should be aware.

1 See, e.g., In re Charter Commun., Inc., 691 F.3d 476, 485 (2d Cir. 2012) (noting that “normally a nonseverability clause standing on its own cannot support a finding of equitable mootness. Allowing a boilerplate nonseverability clause, without more, to determine the equitable mootness question would give the debtor and other negotiating parties too much power to constrain Article III review.”); Patterson v. Mahwah Bergen Retail Group, Inc., 636 B.R. 641, 693 (E.D. Va. 2022) (following In Re Charter and holding that a nonseverability clause in a confirmation order, on its own, does not render an appeal equitably moot).

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