Independent Directors Properly Exculpated as Debtors’ Disinterested Fiduciaries Under Chapter 11 Plan, Southern District of Texas Bankruptcy Court Rules

On March 3, 2025, Judge Marvin Isgur of the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”) held in In re Instant Brands Acquisition Holdings Inc., et al., Case No. 23-90716 (“Instant Brands”) that the Debtors’ chapter 11 plan (the “Plan”) properly exculpated the Debtors’ independent directors for conduct performed within the scope of their duties during the administration of the chapter 11 cases, absent gross negligence or willful misconduct.[1]  The Bankruptcy Court rejected the United States Trustee’s (“U.S. Trustee”) argument that the Fifth Circuit’s ruling in NexPoint Advisors, L.P. v. Highland Capital Management L.P. (In re Highland Capital Management, L.P.), 48 F.4th 419 (5th Cir. 2022) (“Highland Capital”) only permits exculpating independent directors if they are appointed post-petition by court order authorizing them to function as trustees. Judge Isgur found that Highland Capital affirmed that the Bankruptcy Code authorizes exculpation of a bankruptcy trustee unless it acts with gross negligence, 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 decision affirms the inclusion of independent directors as exculpated parties, notwithstanding the otherwise narrow scope of permitted exculpations in the Fifth Circuit.

Chapter 11 Plan Exculpations and Highland Capital

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.[2]

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 Pacific Lumber, the Fifth Circuit Court of Appeals (“Fifth Circuit”) held that this section prohibits the effective release of claims against non-debtor exculpated parties.[3]

In Highland Capital, the Fifth Circuit re-examined the scope of permissible exculpation under Pacific Lumber. In Highland Capital, due to claims of misconduct against the debtor’s co-founder, the U.S. Trustee sought to appoint a chapter 11 trustee to administer the debtor’s estate. Prior to the resolution of the U.S. Trustee’s motion, the debtor and official committee of unsecured creditors reached a settlement that provided for, among other things, (a) the replacement of the debtor’s existing management with a board of three independent directors and (b) protection for the independent directors against claims brought against them in connection with their roles as independent directors—unless the court determined that “such claim or cause of action represents a colorable claim of willful misconduct or gross negligence.”[4]  The bankruptcy court approved the settlement.[5]  The debtors’ chapter 11 plan exculpated certain non-debtor third parties supporting the plan, including a claimant trust, litigation sub-trust, oversight board, parties related thereto, and each of the independent directors, among others. At confirmation, creditors unsuccessfully challenged the confirmation order, in part, on the basis that the exculpation of the independent directors and other third parties was improper.

On appeal, the Fifth Circuit affirmed that the plan’s exculpation of the independent directors and the creditor committee members was lawful, but that its exculpation of the other third parties was not. It recognized a circuit split concerning the effect and reach of section 524(e) of the Bankruptcy Code, noting that the Fifth Circuit along with the Tenth Circuit categorically bars third-party exculpations absent express authority in another provision of the Bankruptcy Code.[6]  However, because it found that 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 Fifth Circuit concluded that the independent directors were lawfully exculpated under the plan.[7]

Instant Brands Chapter 11

In June 2023, Instant Brands commenced chapter 11 cases in the Southern District of Texas. It sought to confirm a plan which provided for, among other things, the exculpation of each of its independent directors “from any Cause of Action for any claim related to, any act or omission in connection with, related to, or arising out of the Chapter 11 Cases, . . . and any other act taken or omitted to be taken in connection with or in contemplation of the Chapter 11 Cases, the reorganization of the Debtors, or the administration of, or property to be distributed under, the Plan . . . , except for claims related to any act or omission that is determined in a Final Order to have constituted willful misconduct (including actual fraud) or gross negligence.”[8]  The independent directors were appointed prepetition and the bankruptcy court had not approved their appointment.

On February 8, 2024, the U.S. Trustee objected to Instant Brands’ chapter 11 plan alleging that it "improperly provides overly broad exculpation coverage to ‘each independent director of the Debtors” in violation of Highland Capital and Pacific Lumber.[9]  The U.S. Trustee argued that Fifth Circuit precedent only authorized exculpation of a debtor’s independent directors if they were “appointed post-petition pursuant to a court order authorizing them to act as trustee,” as occurred in Highland Capital.[10]

On February 23, 2024, the Bankruptcy Court confirmed Instant Brand’s plan, but modified the confirmation order to, among other things, provide that “the independent directors of the Debtors shall not be deemed ‘Exculpated Parties’ pending further order of the Bankruptcy Court; provided, if the Court subsequently authorizes their exculpation, the exculpation will be effective as of the date of entry of this Order.”[11]  At the confirmation hearing on the previous day, the Bankruptcy Court ordered the parties to provide additional briefing with respect to Highland Capital and its effects on the exculpation provision contained in Instant Brands’ plan.[12]

Ruling and Analysis

On March 3, 2025, Judge Isgur issued his opinion rejecting the U.S. Trustee’s argument that Highland Capital only permits exculpation of independent directors if they are court-appointed and authorized to function as a trustee. Finding this interpretation too narrow, Judge Isgur concluded that a “fair reading” of Highland Capital confirms the recognition that the Bankruptcy Code provides debtors-in-possession with all the authority of a bankruptcy trustee to function as the administrator of a debtor’s estate. As a result, because disinterested fiduciaries of a debtor-in-possession, such as independent directors, act pursuant to the same authority and perform the same functions, they are afforded identical protections as the debtors-in-possession regardless of when they are appointed.[13]  Accordingly, Judge Isgur held that Instant Brands’ independent directors were exculpated parties under its plan and were lawfully exculpated for conduct within the scope of their duties—absent gross negligence or willful misconduct.

Conclusion

Judge Isgur’s decision in Instant Brands affirms the inclusion of independent directors as exculpated parties in a properly drafted exculpation provision, notwithstanding the Fifth Circuit’s otherwise restrictive view towards including non-debtor third parties in such provisions. It remains to be seen whether other parties may qualify as sufficiently “disinterested fiduciaries” to similarly benefit from such protections.

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[1]       Memorandum Opinion, In re Instant Brands Acquisition Holdings Inc., Case No. 23-90716 (MI) (S.D.T.X. Bankr. Mar. 3, 2025) [ECF 1451] (“Op.”).

[2]       See In re PWS Holding Corp., 228 F.3d 224, 246 (3d Cir. 2000) (explaining the universal formulation of exculpation provisions carving out willful misconduct and gross negligence).

[3]       See In re Pacific Lumber Co., 584 F.3d 229 (5th Cir. 2009).

[4]       Op. at 4 (quoting Reorganized Debtors’ Supplemental Brief Regarding Exculpation Issues Raised by the United States Trustee, In re Instant Brands Acquisition Holdings Inc., Case No. 90716 (MI) [ECF 1184] (“Debtors’ Brief”) Ex. D. at 3-4).

[5]       The bankruptcy court ultimately ruled that there was no cause for the appointment of a chapter 11 trustee. Op. at 4 (quoting Debtors’ Brief Ex. F at 115-17 (explaining that there were “sophisticated, well-heeled economic stakeholders who have worked mightily to essentially overhaul the entire corporate governance as to this debtor” which “sanitized the problems”)).

[6]       By contrast, courts in the majority of other circuits allow varying degrees of limited third-party exculpations based on factors such as fairness, necessity to the reorganization, and the facts and circumstances of a particular case. See Highland Capital, 48 F.4^th at 437 (citations omitted).

[7]       Id. at 437.

[8]       Combined Disclosure Statement and Joint Chapter 11 Plan of Reorganization of Instant Brands Acquisition Holdings Inc. and its Debtor Affiliates, In re Instant Brands Acquisition Holdings Inc., Case No. 23-90716 (MI) (S.D.T.X. Bankr. Jan. 11, 2024) [ECF 926-1] at 88.

[9]       Limited Objection of United States Trustee to Combined Disclosure Statement and Joint Chapter 11 Plan of Reorganization of Instant Brands Acquisition Holdings Inc. and its Debtor Affiliates, In re Instant Brands Acquisition Holdings Inc., Case No. 23-90716 (MI) (S.D.T.X. Bankr. Feb. 8, 2024) [ECF 1013] at 1.

[10]     Brief in Support of Limited Objection of United States Trustee to Combined Disclosure Statement and Joint Chapter 11 Plan of Reorganization of Instant Brands Acquisition Holdings Inc. and its Debtor Affiliates, In re Instant Brands Acquisition Holdings Inc., Case No. 90716 (MI) [ECF 1183] at 6.

[11]     Findings of Fact, Conclusions of Law, and Order (I) Confirming the Joint Chapter 11 Plan of Reorganization of Instant Brands Acquisition Holdings Inc. and its Debtor Affiliates and (II) Approving the Disclosure Statement on a Final Basis, In re Instant Brands Acquisition Holdings Inc., Case No. 23-90716 (MI) (S.D.T.X. Bankr. Feb. 23, 2024) [ECF 1146] at ¶ 29.

[12]     Op. at 2.

[13]     Op. at 6 (citing Highland Capital, 48 F.4th at 437; 11 U.S.C. § 1107(a)).