Opt-in or opt-out? The ongoing debate over consensual third-party releases in Chapter 11 cases

Introduction

Bankruptcy courts across the United States are engaged in a significant debate over how creditors demonstrate consent to releases of claims against non-debtors in a Chapter 11 plan, i.e. consensual third-party releases. One perspective holds that a creditor’s silence – its failure to actively “opt-out” of the release – implies consent. The other view insists on affirmative action, requiring a creditor to explicitly “opt-in” to the release to show consent.

While this debate over what qualifies as consent is not new, the Supreme Court’s decision in Harrington v. Purdue Pharma L.P. has amplified its importance. In Purdue, the Supreme Court ruled that bankruptcy courts lack the authority to confirm a Chapter 11 plan that allows for non-consensual third-party releases. The Court made clear, however, it was not deciding the legality of consensual third-party releases, which, unlike non-consensual releases, give creditors the opportunity to decline to give the release in the proposed plan. With non-consensual third-party releases off the table, the focus has shifted to the nuances of what constitutes “consensual.” This in turn has prompted numerous courts across the country to re-examine the validity of the “opt-in” and “opt-out” approaches.

This article explores the essential role of consensual third-party releases in the restructuring of financially distressed companies under Chapter 11. It also examines the ongoing legal debate over what constitutes consent and the Spirit Airlines decision, a recent ruling from the Bankruptcy Court for the Southern District of New York that contributes to this evolving area of law.

The importance of third-party releases

Before we address the split, it’s worth asking why third party releases and the approach to determining consent matter. From this author’s perspective, third-party releases are a powerful tool to address the collective action problem posed by financial distress and maximize recoveries for creditors. The availability and application of this tool, therefore, has profound implications for creditors’ and debtors’ rights in Chapter 11 proceedings.

The absence of a mandatory and centralized process for addressing creditor claims against a failing company incentivizes creditors to “race to the courthouse” to pursue legal action and other forms of self-help to seize the company’s assets before other creditors slower to act. This free-for-all often leads to the destruction of the company’s value and its breakup before it has a chance to reorganize and salvage value for the benefit of all creditors. US bankruptcy law is designed to address this problem by imposing a collective, compulsory process ensuring the fair distribution of the debtor’s assets to creditors based on their priority, preventing the dismemberment of the debtor’s estate and maximizing the value of the common pool of assets available to pay creditor claims.

Third-party releases help mitigate this collective-action problem in the following ways:

• They incentivize non-debtors, particularly those who may hold valuable assets and are targets of litigation for a company’s downfall, such as insiders and non-debtor affiliates, to contribute funding to a debtor’s reorganization in exchange for protection from lawsuits. This encourages comprehensive settlements and can lead to an overall increase in value of the bankruptcy estate to the benefit of all creditors.
• They may allow a company to avoid costly and unpredictable litigation that may hinder its reorganization prospects. For example, when a debtor has an obligation to indemnify a third party, like a director or officer, a third party release may prevent a substantial indemnification claim from arising against the debtor.
• They have the effect of limiting the power of unreasonable holdout behavior by creditors demanding full payment of their claims so that creditors can be bound once the statutory voting majorities for approving a Chapter 11 plan are achieved.

Opt-in vs. opt-out: the divergent approaches to showing consent to a third-party release explained

As introduced above, courts have typically evaluated a creditor’s consent to a third-party release through two different mechanisms, either an “opt-out” or an “opt-in” protocol. Under an “opt-out” model, courts view a creditor’s failure to act ‒ when provided with notice that its inaction will result in legal consequences ‒ as sufficient indication of the creditor’s consent. In practice, this means the debtor sends a ballot or opt-out form to creditors that clearly explains that the ballot or opt-out form must be returned and the “opt-out” box checked if the party elects not to approve the third-party release. Conversely, under the “opt-in” approach, courts require some affirmative indication of acceptance of the release to show consent. Typically, this means creditors must affirmatively check an “opt-in” box on a form or ballot cast for voting on a plan to be bound by the release.

These approaches diverge based on their underlying legal justifications. Courts favoring the opt-out method often emphasize the significant legal ramifications of inaction in bankruptcy proceedings or civil litigation following appropriate notice. For example, a defendant’s failure to respond to a properly served complaint may result in the court’s acceptance of the complaint’s allegations as true and issuance of a default judgment for damages. Similarly, creditors in a bankruptcy case that neglect to file a proof of claim by the established bar date risk permanently losing their claims against the debtor. In addition, counterparties to leases and contracts may be bound by the debtor’s valuation of cure amounts for pre-bankruptcy defaults if they remain silent during the proceedings. Conversely, courts adopting the “opt-in” method often frame a creditor’s consent within a contractual framework, emphasizing that contract formation generally requires affirmative assent, not mere silence or inaction.

How these different approaches to consent affect creditors, depends on where the creditors stand in the Chapter 11 case:

• Creditors voting to accept a plan. Under either the “opt-out” or “opt-in” approach, most courts agree that creditors who affirmatively vote in favor of the plan may be bound by the releases because voting for the plan is a sufficient indication of consent.
• Creditors voting to reject a plan. For creditors who vote to reject the plan, the “opt-out” approach would bind the creditors unless they take the affirmative step of checking the opt-out box on a ballot, i.e. the creditor made an active choice to return the ballot without checking the opt-out box. Conversely, the “opt-in” approach would generally not bind the rejecting creditor unless it affirmatively checked the opt-in box.
• Non-voting creditors deemed to accept or reject the plan/voting creditors who fail to cast a ballot. The more difficult question concerns creditors who either failed to return ballots or were not entitled to vote at all (because they were presumed to accept or reject the plan’s terms under the Bankruptcy Code). Under the “opt-in” approach, creditors who were not solicited to vote or failed to return a ballot and therefore have not expressly consented to releases would not be bound by them. However, under the “opt-out” method, these same creditors may be bound by the releases unless the creditor files an objection to the release or fails to separately return an opt-out form or ballot that checks the box to opt out. Several courts that have otherwise applied the opt-out model have declined to presume consent to a release by creditors deemed to reject a plan. In those cases, the deemed to reject class typically consists of equity holders whose interests are eliminated under the plan or other classes of creditors with little or no economic incentive to participate in the Chapter 11 case.

With diverging approaches yielding different results in courts across the US ‒ even by different judges within the same courthouse – the debate over whether an “opt-out” or “opt-in” model is appropriate is likely to continue until appellate courts weigh in.

Recent developments in the evolving landscape of third-party releases: Spirit Airlines

In the Chapter 11 case of Spirit Airlines, the US Bankruptcy Court for the Southern District of New York recently issued a decision applying the opt-out approach to approving consensual third-party releases in the budget airline’s Chapter 11 plan of reorganization.

Background

At the time of its bankruptcy filing, Spirit Airlines was the seventh largest airline in the US. The debtors, their subsidiaries, and affiliates operated the airline as an “ultra-low-cost carrier” servicing destinations throughout the US, Latin America, and the Caribbean. In November 2024, the debtors initiated Chapter 11 bankruptcy proceedings to implement a comprehensive restructuring supported by stakeholders holding 80% of the debt to be restructured under the plan (amounting to over US$1 billion). The parties contemplated a series of restructuring transactions, including the equitization of senior secured and convertible notes in the form of new equity interests in the reorganized parent company. As part of the negotiated restructuring support agreement, general unsecured claims would either be paid in full or “ride through” the bankruptcy case unaffected, i.e. left “unimpaired” under the US Bankruptcy Code. The bankruptcy court found that without the consenting stakeholders’ agreement to convert their debt to equity, unsecured creditors would be fortunate to receive little, if any, recovery.

The debtors sent a ballot with an opt-out box to voting creditors and an opt-out form to non-voting creditors, but only those deemed to accept the plan. Under the plan, voting creditors were deemed to have consented to the third-party releases if they cast a vote or abstained from voting but did not check the opt-out box on their ballot by the voting deadline. Excluding creditors deemed to have rejected the plan, non-voting creditors were required to check the opt-out box on their opt-out forms to show they did not consent to the releases. Creditors and equity holders deemed to reject the plan were not subject to the release and therefore were not sent an opt-out form. Both voting and non-voting creditors could alternatively file an objection with the Bankruptcy Court to avoid being bound by the releases. The Chapter 11 plan, disclosure statement, ballots, and opt-out forms prominently featured information about the releases and instructions on the procedures to opt out of them.

Both the Securities and Exchange Commission and the Office of the United States Trustee filed objections to the opt-out protocol, arguing that the third-party releases were not consensual and therefore violated Purdue. The Bankruptcy Court overruled these objections in a thoughtful decision spanning nearly 50 pages.

Analysis

After examining the state of the law on third-party releases and diverging views on what consent looks like, the Court laid out several considerations courts in the Second Circuit and the Southern District of New York (the appellate courts to which the Spirit Airlines’ Bankruptcy Court answers) have looked to evaluate whether an opt-out mechanism should be approved:

• The circumstances of the proposed releasing parties, including whether the creditors have any economic disincentive to follow the bankruptcy case;
• The procedural history of the bankruptcy case and whether the release has been clearly and consistently presented to affected creditors;
• General principles of contract law; and
• In the mass tort context, whether creditors are largely represented by counsel and the extent of counsel’s involvement in the case, the consideration from the to-be-released parties offered in exchange for the third-party releases, including how that consideration affects recoveries to creditors, and the risk that using an opt-in procedure would cause the released parties to withdraw their contributions.

Turning to the case at hand, the Court focused on several key features of the case and the opt-out procedure. The opt-out protocol was explained clearly and prominently in the plan, ballots, opt-out forms, and in other court filings since the beginning of the bankruptcy. 190 ballots and opt-out forms were received from creditors electing to opt-out of the releases, suggesting that creditors understood how to exercise their right to do so. A full recovery was promised to unsecured creditors, which meant they had a strong economic incentive to follow the bankruptcy. The plan was overwhelmingly supported by voting creditors, 98.1% of creditors consented in writing through the RSA to grant the releases. As the seventh largest airline in the US, the case had drawn significant media attention. Importantly, the official committee of unsecured creditors, the body charged with representing all of Spirit Airlines’ unsecured creditors in Chapter 11, did not challenge the opt-out protocol.

A few additional points about Spirit Airlines are worth highlighting. The decision addressed the contractual arguments raised by the objectors that are often relied on by parties in support of an opt-in model. The Court observed that applying a contract theory to the releases reliant on state law presents a choice of law problem. A creditor’s treatment in a bankruptcy case is governed by federal bankruptcy law in the context of a collective bankruptcy proceeding. Having to decide which state’s contract law applies for numerous different creditors would prove unworkable. Other courts have observed that applying portions of state contract law, i.e. the parts dealing with offer and acceptance, but not the entire body of law could prove equally unworkable.

The Spirit Airlines Bankruptcy Court further reasoned that if general contract principles could apply, silence and inaction may operate as acceptance of third-party releases under appropriate circumstances. For example, acceptance of a contract may be presumed when its benefits are accepted with a reasonable opportunity to reject them and reason to know the benefits were offered with the expectation of compensation. Spirit Airlines’ creditors were offered the opportunity to accept or reject the third-party releases. Under the plan, creditors received and accepted the benefit of the restructuring support agreement in the form of hundreds to millions of dollars in value contributed by the consenting stakeholders. Without that contribution, unsecured creditors would have likely received little or no value in Chapter 11. The affected creditors, the Court opined, had every reason to know of this bargain and its benefits based on the disclosures made throughout the case. Thus, the Court concluded that the exception applied. The Court also rejected the argument that each third-party release must be viewed as a separate, unsolicited offer to the affected creditor by the recipients of the release. Referring to that view as “divorced from reality,” the Court concluded it was more appropriate to examine the question of consent through the framework of the plan (the broader contract at issue) and the Chapter 11 process.

Takeaways

Spirit Airlines provides meaningful guidance on the evolving law on consensual third-party releases in Chapter 11. The debate is likely to continue as the process winds its way through the courts. Though the specific circumstances of each case will dictate whether a proposed opt-out mechanism is appropriate, Spirit Airlines shows that a court is more likely to approve an opt-out if the procedure itself and notice of the legal consequences of inaction are clearly and prominently disclosed as soon as possible in the Chapter 11 case, and the opt-out protocol is actually utilized by affected creditors, who have a meaningful economic incentive to participate in the plan process.