SDNY Bankruptcy Court approves settlement agreements with nonconsensual third-party releases for insurance companies

In the chapter 11 bankruptcy case of In re Roman Catholic Diocese of Rockville Centre, New York, Case No. 20-12345 (MG), the US Bankruptcy Court for the Southern District of New York recently approved settlement agreements with four insurance companies involving the buyback by the insurers of certain insurance policies, the proceeds of which provided funding for the Roman Catholic Diocese of Rockville Centre (the Debtor)’s plan of reorganization.

In so doing, on November 18, 2024, the Court overruled an objection that the settlements contained improper nonconsensual third-party releases and injunctions in contravention of the US Supreme Court ruling in Harrington v. Purdue Pharma L.P., 144 S. Ct. 2071 (2024).

The Court held that the Debtor’s sale of the policies represented a sound exercise of the Debtor’s business judgment that satisfied the requirements of Bankruptcy Code Section 363. Section 363 therefore entitled (a) the Debtor to sell the policies free and clear of third-party interests under Section 363(f) and (b) the insurers and purchasers to protection from third-party claims as good-faith purchasers under Section 363(m).

Factual background

The Debtor filed for chapter 11 protection on October 1, 2020 (the petition date) in response to hundreds of sexual abuse claims asserted against the Debtor following the enactment by New York State of the Child Victims Act (CVA).

The CVA revived certain previously time-barred causes of action and extended the statute of limitations under which certain civil and criminal actions arising out of the sexual abuse of minors may be brought. Prior to the petition date, the Debtor engaged in substantial efforts to identify and locate insurance policies and secondary evidence of insurance coverage from the late 1950s to the present – all designed to provide as much coverage as possible for those claims.

On the petition date, the Debtor filed an adversary proceeding against various of its insurers seeking insurance coverage for the abuse claims that had been brought against the Debtor. The insurers moved to withdraw the reference to the Court, and the litigation was transferred to the US District Court for the Southern District of New York as four separate cases. In those cases, the insurers disputed coverage and sought declaratory judgments seeking to limit or eliminate coverage.

Commencing in October 2021, the Debtor and the insurers engaged in mediation. When those efforts to reach a settlement failed, the Debtor sought confirmation of a chapter 11 plan. That plan failed to gain Court approval, and the Debtor sought to dismiss its bankruptcy case. Rather than ruling on that motion, in May 2024, the Court appointed former Bankruptcy Judge Shelley Chapman and Paul Finn to serve as co-mediators. This time, the mediation resulted in a global settlement with the insurers.

Under the terms of the settlement, embodied in separate settlement agreements with each of the four settling insurers, the settling insurers agreed to make contributions aggregating $85 million to a settlement trust for the benefit of abuse survivors. Together with other contributions, the settlement pool for claimants to be administered by the trust exceeded $320 million.

The parties structured each settlement agreement as a sale of the relevant policies back to the insurers (the policy sales). The settlement agreements included as a key condition that the policy sales would be free and clear of all claims and interests, and that all parties in interest – including the survivors of alleged abuse – would be enjoined from pursuing any claims against the insurers arising from, related to, or connected in any way with any of the policy sales.

The releases and injunctions in the sale order would also apply to claims against other nondebtor affiliates of the Debtor, despite those entities not being debtors in a bankruptcy case. The Debtor contended that these releases and injunctions represented a sound exercise of its business judgment as a necessary component of the policy sales, the settlement agreements, and the Debtor’s reorganization.

The effectiveness of each settlement agreement was conditioned on confirmation of the Debtor’s chapter 11 plan, but the plan was not conditioned on approval of the settlement agreement. However, the plan required abuse claimants to execute releases in favor of nondebtor third parties (eg, the settling insurers) in order to receive a distribution under the plan from the trust.

The plan also contained a “gatekeeper” provision that precluded claimants from commencing or pursuing certain nondebtor third parties called “Protected Parties” – which included the Debtor, the settling insurers, and any individual local churches and parish schools that subsequently seek bankruptcy protection – without such claimants first obtaining a Bankruptcy Court order (a) holding that such claims were colorable and (b) authorizing the claimants to pursue such claims.

Consequently, the terms of the settlement agreement and the Debtor’s plan created two sets of releases: (i) a nonconsensual injunction and release in the settlement agreement that barred claims against nondebtors related to the policy sales and (ii) consensual releases against nondebtors as a condition to receipt of certain plan distributions.

The Debtor filed a motion seeking approval of the settlement agreements on November 1, 2024. On November 8, 2024, the US Trustee (UST) filed an objection including, among other issues, that:

• The nonconsensual release and injunction provisions in the settlement agreements were impermissible under the Supreme Court ruling in Purdue Pharma, and the Debtor could not use Bankruptcy Code Section 363 to obtain nondebtor releases and injunctions through a sale that would not be available under a chapter 11 plan
  
  
• The bankruptcy plan’s “gatekeeper” provision would improperly vest exclusive jurisdiction over claims involving only nondebtors in the Court, precluding claimants from pursuing their claims in their preferred forum, and
  
  
• If a survivor’s entitlement to a plan distribution turned on whether the survivor had executed the third-party release, such disparate treatment could run afoul of the classification requirements of Bankruptcy Code Section 1123.

In reply, the Debtor argued that, in sale orders, courts routinely grant injunctive protection to purchasers of assets in chapter 11 cases. The Debtor stated that the language in the sale order was similar to the sale orders entered in the Chrysler and General Motors chapter 11 cases and appropriately protected purchasers from claims relating to the purchased property.

The reply also argued that the UST’s attempt to extend the Supreme Court’s ruling in Purdue Pharma – which held only that Bankruptcy Code Section 1126(b)(6) does not support nonconsensual third-party releases in a chapter 11 plan – was misguided, as nothing in Purdue Pharma purported to impact injunctive relief entered in connection with sale orders.

The Debtor further maintained that the sale order injunction was narrowly tailored to the specific facts presented and did not purport to enjoin direct claims of creditors against nondebtor insurers for the insurers’ own misconduct.

Legal standards

The Court explained that Bankruptcy Code Section 363(b) authorizes a debtor to sell assets outside the ordinary course of business, following notice and a hearing, provided the debtor can establish that the sale is the supported by a sound business justification. Whether a sound business justification exists turns on the specific facts and circumstances presented.

In addition, Bankruptcy Code Section 363(f) authorizes a debtor to sell assets free and clear of any interests in the property if one of several criteria are satisfied, including if:

“(1) applicable nonbankruptcy law permits sale of such property free and clear of such interest;

(2) such entity consents;

(3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property;

(4) such interest is in bona fide dispute; or

(5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.” 11 U.S.C. § 363(f).

The Court also explained that a good-faith purchaser of assets is entitled to protection under Bankruptcy Code Section 363(m) if the sale order is later reversed, preventing the sale from being unwound. The good faith of a purchaser, the Court stated, can be “shown by the integrity of his conduct during the course of the sale proceedings,” while fraud, collusion, or an attempt to take “grossly unfair advantage of other bidders” will preclude a finding of good faith.

With regard to approval of a settlement, the Court noted that Bankruptcy Rule 9019 permits approval of a settlement following notice and a hearing if the settlement is found to be “fair and equitable.” In making this assessment, courts in the Second Circuit typically apply the “Iridium Factors”, see Motorola, Inc. v. Off. Comm. Of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452, 462 (2d Cir. 2007), which include consideration of:

• The likelihood of success in litigation compared to the benefits of the settlement
• The likelihood of protracted and expensive litigation
• The interests of creditors
• Whether other parties in interest support the settlement
• The competency and experience of counsel
• The scope of releases granted to officers and directors, and
• Whether the settlement was the product of arm’s length negotiations.

In order to gain court approval, a settlement does not need to be the best deal possible; rather, it only needs to fall within the lowest range of reasonableness, and deference must be afforded to the debtor’s business judgment.

The Bankruptcy Court ruling

The Court entered the sale order and overruled the UST objection in all respects. Having set forth the applicable standards for the relief requested under Bankruptcy Code Section 363(b), the Court held that the proposed sale was a sound exercise of the Debtor’s business judgment. The Court observed that the settlement was negotiated at arm’s length and in good faith, would make funds available for immediate distribution to creditors, and resolved contentious litigation that otherwise could take years to resolve.

Moreover, the settlement agreements satisfied the other customary elements required for approval under Bankruptcy Rule 9019, including striking a balance between the risk and cost of extended litigation and the benefits of the settlement, serving the paramount interest of creditors, and enjoying broad support from interested parties.

The Court further held that the sale of the insurance policies satisfied the requirements of Bankruptcy Code Section 363(f), so that the transfer of assets to the purchasers would be free and clear of all claims and interests. The Court credited the Debtor’s statement that any entity with a lien on or interest in the policies had consented, and noted in any event that no party in interest other than the UST had objected.

With regard to the injunctions in the sale orders, the Court observed that courts routinely grant such relief to protect asset purchasers. Last, because the settling insurers had participated in the mediations and negotiations in good faith, the Court determined that they were entitled to the protection of Bankruptcy Code Section 363(m), such that the modification or reversal of the sale orders on appeal would not impact the validity of the asset sales.

Although the UST had characterized the proposed settlements as an effort to “evade Purdue and achieve through a Section 363 sale what they could not through a plan,” the Court never directly addressed this argument. Instead, the Court appears to have adopted the view expressed by the Debtor, namely that the UST’s efforts to extend Purdue to the context of a pre-plan sale was an “overreach.” The Court never expressly stated that Purdue should be limited to third-party releases under a plan, but that may be the practical effect of this ruling.

Key takeaways of Rockville Centre

The Rockville Centre ruling highlights the ongoing uncertainty concerning the permissible scope of nonconsensual third-party releases in the aftermath of Purdue Pharma. While Purdue Pharma is arguably limited to releases granted in the context of confirmation of a chapter 11 plan, Rockville Centre provides a roadmap for parties to obtain nonconsensual third-party releases through a sale and settlement, even if the proposed sale is a key component of a chapter 11 plan.

Chapter 11 debtors may be able to use the sale process under Bankruptcy Code Section 363(b) to grant these releases if including the releases as a term of the sale is supported by a sound business justification. However, unlike the broad, general releases often granted under a chapter 11 plan, the scope of releases granted in connection with an asset sale may be limited to claims arising from, or related to, the assets subject of the sale.

The Court never directly addressed the propriety of the plan conditioning certain distributions on claimants executing releases. Under the plan, a claimant would be free to decline to execute the requested release, but would then forgo their distribution from the trust.

For more information

If you have any questions about this ruling or any restructuring-related matter, please reach out to the authors, Robert Klyman and Scott C. Shelley, or your usual DLA Piper contact.