Takeaways
- In removing a valuable tool to entice co-liable non-debtors that may have significant assets to contribute to a global resolution of claims, the Purdue Pharma decision will make it more difficult for debtors facing mass tort liabilities to craft workable and comprehensive resolutions in bankruptcy. This could make it more challenging for victims of mass torts to achieve recoveries and could burden courts with protracted and redundant litigation.
- The decision was clear that it was not intended to call into question the legality of consensual third-party releases that are a feature of a significant portion of large Chapter 11 cases. However, the determination of what constitutes “consent” for purposes of a third-party release could become a focus of future plan confirmation litigation.
- The decision will also have serious implications beyond mass tort bankruptcies and could complicate restructurings in numerous other contexts, including with respect to Chapter 11 plans that have already been negotiated or proposed. Debtors have now lost an arrow in their quiver to help resolve complex restructurings.
Introduction
Few issues in US bankruptcy cases rile more emotion and controversy than the use of non-consensual third-party releases to discharge potential tort liability against persons who are themselves not debtors in bankruptcy. Once considered “extraordinary”, non-consensual third-party releases are ubiquitous in Chapter 11 plans today. The use of non-consensual third-party releases in high profile mass tort reorganizations such as Purdue Pharma, Boy Scouts of America and the bankruptcy cases of various dioceses and churches has shined a new spotlight on third-party releases and made them a target of political and popular scorn. The use of non-consensual releases is not without controversy. Indeed, there is a clear split among the Federal circuits, with the majority concluding that non-consensual releases are authorized under federal bankruptcy law in certain, unusual circumstances while the others have concluded that they are fully prohibited and without authorization under the U.S. Bankruptcy Code.
The U.S. Supreme Court has finally spoken on the issue and put the controversy to rest in Harrington v. Purdue Pharma L.P., holding that non-consensual third-party releases are simply not permitted under the U.S. Bankruptcy Code (outside of asbestos). The decision will have far reaching consequences and effectively ends the use of a tool that has been used with success to resolve mass tort litigations through bankruptcy. The holding is not limited to mass tort cases and will potentially complicate efficient resolutions of other Chapter 11 cases where such releases have been critical components of approved Chapter 11 plans. Importantly, the decision leaves intact the use of consensual releases under Chapter 11 plans.
Historical and Legal Background of Third-Party Releases
In the context of a Chapter 11 reorganization, a non-consensual third-party release discharges claims held by creditors against a non-debtor entity who may be a co-obligor with the debtor, such as an officer, director or parent of a debtor, in exchange for a financial or other contribution from the non-debtor to resolution of the liabilities of the debtor under a plan. The release is imposed without the consent of the claimant. The third-party release allows non-debtor affiliates who are not in bankruptcy to reap the benefit of a discharge typically reserved for a debtor. Such relief generally is limited to circumstances where the non-debtor released party has made a valuable contribution in exchange for the release.
Third-party releases present a number of controversies from legal and policy perspectives. In effect, the releases permit non-debtors to shield themselves from liability, including potentially from severe allegations of wrongdoing. Non-debtors receive a discharge without subjecting themselves to the requirements imposed on bankruptcy debtors, including that the debtor marshal all of its assets for distribution to creditors in accordance with bankruptcy priorities. Tort victims, in short, lose their opportunity to sue accused wrongdoers in court and to seek redress from released parties. Their recourse is limited to the consideration provided under the debtor’s Chapter 11 plan. Because the ability of a debtor to propose a feasible mass tort Chapter 11 plan often depends heavily on the financial contribution of the non-debtor party, the non-debtor party has significant leverage to push for broad releases.
Courts have been split on the legality of third-party releases for nearly forty years culminating in the Supreme Court’s decision in Purdue Pharma L.P. In the 1980s, the Johns-Manville asbestos bankruptcy cases brought non-consensual third-party releases to light.[1] The company faced thousands of asbestos liability claims, leaving them potentially liable for more than $2 billion. With the company’s $1 billion net worth, Manville had no choice but to file for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. The settlement agreement with their insurance providers was a crucial step in the Manville Chapter 11 reorganization. The insurers paid roughly $800 million into the bankruptcy estate in exchange for third-party releases. The Bankruptcy Court approved the releases and the Second Circuit Court of Appeals ultimately affirmed, noting that the claims against the non-party insurers would have a direct impact on the Manville’s property and were therefore within its jurisdiction to resolve.
In 1994, Congress amended the U.S. Bankruptcy Code through the Bankruptcy Reform Act, adding Section 524(g), which expressly allows non-consensual releases of non-debtor co-tortfeasors but only in asbestos cases. The use of similar non-consensual third-party releases has also been a relatively common feature of non-asbestos mass tort cases, used to protect non-debtor affiliates against mass tort litigation on issues like sex abuse, opioids, and product liability.
The Bankruptcy Code does not otherwise explicitly provide that non-party debtors may be released in a bankruptcy proceeding (except in the context of asbestos-related claims) and prior to Purdue Pharma the Supreme Court never considered the issue. Because of this, jurisdictions are split on the permissibility of these releases. Non-consensual third-party releases are permitted in a majority of bankruptcy courts, including those in the Second, Third, Fourth, Sixth, Seventh, and Eleventh Circuits.[2] Courts that permit such releases consider a wide range of factors in making their decisions, such as whether the releases or injunctions are essential for reorganization, if the parties being released have made or are making significant financial contributions to the reorganization, whether the plan will have a mechanism to pay at least substantially all of the class(es) affected by the injunction, or whether the majority of creditors involved approve of the plan[3].
Meanwhile, the minority view adopted by the Fifth, Ninth, and Tenth Circuits holds that non-consensual third-party releases are impermissible, with a narrow exception in the Ninth Circuit allowing for such releases for conduct occurring within the bankruptcy proceeding.[4] These courts generally interpret Section 524(e) of the Bankruptcy Code as precluding bankruptcy courts from discharging liabilities of non-debtors, therefore prohibiting non-consensual third-party releases.[5]
Factual and Procedural Background
Purdue Pharma was a privately held company owned and operated by the Sackler family for almost 70 years at the time of its bankruptcy filing. Certain members of the Sackler family held various director and officer positions at the company over the years and Purdue Pharma had agreed to indemnify directors and officers for claims made against them in connection with their service to the company, except where a court found that their actions were not in good faith.
Purdue Pharma’s introduction and aggressive marketing of OxyContin, a synthetic opioid said to have less-addictive qualities based on a purported timed-release formulation, helped propel an epidemic of opioid addition, resulting in many cases of addiction and overdose deaths. A wave of tort litigation by individuals, surviving families and federal, state and local governments followed, threatening to swamp both Purdue Pharma and the Sacklers. Anticipating the potential for sprawling liability against Purdue Pharma and the Sacklers arising out of the opioid crisis, the Sacklers had caused Purdue Pharma to distribute approximately $10.4 billion to trusts that benefitted the family between 2008 and 2017. However, a significant portion of those distributions went to pay taxes or were in spendthrift trusts or offshore entities that claimants may not have been able to reach through litigation or through a bankruptcy court.
Purdue Pharma filed for Chapter 11 relief on September 15, 2019. The Bankruptcy Court temporarily extended the automatic stay to enjoin all litigation, with claims estimated in excess of $40 trillion in the aggregate, against Purdue Pharma and the Sacklers shortly thereafter. The value of Purdue Pharma’s bankruptcy estate was estimated to be approximately $1.8 billion.
Purdue Pharma entered into an extensive multi-phase mediation with, among other parties, private claimants, state and local governments and the Sacklers. The mediation ultimately resulted in a proposed plan of reorganization under which the Sacklers would contribute $4.275 billion (later increased to $5.5 to $6 billion) to Purdue Pharma’s estate over the course of a decade to be distributed to claimants. In exchange, the Sacklers (and various related parties) would receive releases from Purdue Pharma and from all of its creditors of any causes of action “(x) based on or relating to, or in any manner arising from, in whole or in part, (i) the Debtors . . . (ii) the Estates, or the Chapter 11 Cases and (y) as to which any conduct, omission or liability of any Debtor or any Estate is the legal cause or is otherwise a legally relevant factor.” Notably, the release did not carve out claims for fraud and willful misconduct.
Claimants that responded to the plan’s solicitation of votes voted overwhelmingly to support the plan, with 97% of voting claimants accepting. Notably, fewer than 20% of eligible claimants participated in the voting, a point that the U.S. Supreme Court emphasized in its recent decision. State and local governments were also largely supportive.
After an extended evidentiary hearing, the Bankruptcy Court confirmed the plan, finding that the releases were necessary to the reorganization and, without them, the plan would unravel and Purdue Pharma would end up in a liquidation where most claimants would see their recoveries greatly diminished or eliminated altogether. The Bankruptcy Court also found that it had authority to grant the releases under Section 105(a) and Section 1126(b) of the Bankruptcy Code. Section 105(a) states that “[t]he court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code].” Section 1123(b)(6) further states that “a plan may . . . include any other appropriate provision not inconsistent with the applicable provisions of [the Bankruptcy Code].” The court concluded that these sections provided sufficient authorization for the releases, provided that the claims being released were sufficiently intertwined with Purdue Pharma’s conduct.
On appeal to the United States District Court, the confirmation order was overturned. The District Court held that because the Bankruptcy Code does not specifically provide for non-consensual third-party releases outside of the asbestos litigation context, the releases provided for in Purdue Pharma were not permissible.
The United States Court of Appeals for the Second Circuit reversed the District Court’s decision, holding that the Bankruptcy Code authorized the plan’s non-consensual third-party releases. The Second Circuit concluded that Sections 105(a) and 123(b)(6) confer broad equitable power on bankruptcy courts that “is limited only by what the Code expressly forbids, not what the Code explicitly allows.” Because there are no provisions of the Bankruptcy Code that explicitly state that non-consensual third-party releases are prohibited, such releases are allowed if appropriate under the circumstances.
The Second Circuit recognized that third-party releases pose a “heightened potential for abuse” and should be allowed “only in rare cases.” It therefore clarified the criteria under which non-consensual third-party releases are permitted by adopting a seven-factor test for assessing whether a proposed release is appropriate.
- Whether there is identity of interest between the parties, including indemnification relationships;
- Whether claims against the debtor and non-debtor are factually intertwined;
- Whether the scope of the releases is appropriate;
- Whether the releases are essential to the reorganization;
- Whether the non-debtor contributed substantial assets to the reorganization;
- Whether the impacted class of creditors “overwhelmingly” voted in support of the plan with the releases; and
- Whether the plan provides fair payment of enjoined claims.
In applying that test to the Purdue Pharma releases, it found that the releases were appropriate due primarily to the intertwined nature of the claims against Purdue Pharma and those against the Sacklers, the potential impact that Purdue Pharma’s obligation to indemnify the Sacklers would have on the estate, the necessity of the releases to the reorganization, the substantial funding the Sacklers made to the estate to fund distributions to claimants and the overwhelming support of claimant constituencies.
The United States Trustee, an arm of the Department of Justice that acts as a watchdog for bankruptcy cases, along with a handful of claimants, appealed the Second Circuit’s decision. The Supreme Court granted certiorari on the question of whether the Bankruptcy Code permits a release that extinguishes claims held by non-debtors against non-debtor third parties, without the claimants’ consent.
U.S. Supreme Court Decision
The U.S. Supreme Court held that “the bankruptcy code does not authorize a release and injunction that, as part of a plan of reorganization under Chapter 11, effectively seeks to discharge claims against a nondebtor without the consent of affected claimants.” In doing so, it rejected the Second Circuit’s reading of Section 1123(b)(6) of the Bankruptcy Code’s catchall provision as allowing any provision that does not explicitly conflict with another provision of the Bankruptcy Code. Rather, it held that Section 1123(b)(6)’s use of the term “appropriate” must be informed by the other features of a plan of reorganization permitted by Section 1123(b), each of which allows for the adjustment of the claims of the debtor, not non-debtor third parties. Noting the profound nature of imposing a discharge on third parties without their consent, the Court concluded that if Congress had intended to provide such a “capacious new power” to bankruptcy courts, it would have said so expressly in the Bankruptcy Code.
The decision largely sidestepped the practical implications that the decision may have for the Purdue Pharma plan, stating that it was for Congress rather than courts to decide the proper scope of permissible releases in light of the practical and policy implications. The court expressly declined to address the propriety of consensual third-party plan releases, or what qualifies as consent in that context, or whether the decision would justify unwinding previously confirmed plans that imposed non-consensual third-party releases.
The court reversed the Second Circuit decision and remanded the case for further proceedings at the lower courts.
Implications
On the one hand, Purdue Pharma provides needed clarity on a long running legal dispute regarding the merits of non-consensual third-party releases. However, it does so in a way that will unsettle assumptions that have long formed the foundation for mass tort bankruptcy solutions and the decision opens up new questions regarding third-party releases generally, which could have far-reaching implications in all Chapter 11 cases.
The decision will undoubtedly make resolving mass tort litigations much more difficult. An approach centered on a co-liable party contributing significant assets to fund a global resolution of all claims will be difficult to sustain where a non-debtor party cannot be assured of an end to prospective litigation and liability. As a result, with less available funding, debtors are likely to have more difficulty enticing claimants to resolve claims even against debtors themselves. This raises the specter that mass tort bankruptcies will be more prone to becoming straight liquidations under Chapter 7 that could destroy the value of their going concern businesses that otherwise could inure to the benefit of tort creditors and other stakeholders.
The decision may also impose an additional burden on courts. Bankruptcy cases presented a more efficient mechanism for resolving a myriad of mass tort claims against numerous co-liable parties in a single forum with established norms of due process and court supervision. While multi-district litigation panels and other existing procedural mechanisms may be able to streamline litigation to an extent, the administrative burden and legal costs of proceeding with such litigations rather than resolving them through bankruptcy could be massive and value destructive.
More broadly, although the court was clear that its decision is not intended to speak to the propriety of consensual third-party releases, which are ubiquitous in corporate Chapter 11 plans, the decision may nonetheless have an impact in practice. It remains an open and disputed question among various jurisdictions (and sometimes within jurisdictions) what constitutes “consent” with respect to a third-party release imposed on creditors. Bankruptcy judges may be more reluctant to permit releases based on negative notice “opt out” mechanisms given the Supreme Court’s strict prohibition on non-consensual releases. To the extent the availability of third-party releases becomes more constrained, agreeing to participate in a consensual Chapter 11 process may be less appealing to third parties hoping to get total and permanent resolution of claims through a bankruptcy case.
Acknowledgments to Eric Shi and Ted Gomes for their contribution to this post.
Footnotes
1. See MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89, 91 (2d Cir. 1988)
2. See Gilman v. Cont’l Airlines (In re Cont’l Airlines), 203 F.3d 203 (3d Cir. 2000); Nat’l Heritage Foundation v. Highbourne Foundation, 760 F.3d 344 (4th Cir. 2014); In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002); In re Airadigm Communications, Inc., 519 F.3d 640 (7th Cir. 2008); SE Prop. Holdings, LLC v. Seaside Eng’g & Surveying, Inc. (In re Seaside Eng’g & Surveying, Inc.), 780 F.3d 1070 (11th Cir. 2015).
3. See Dow Corning Corp., 280 F.3d at 658.
4. See Bank of N.Y. Tr. Co. v. 9 Official Unsecured Creditors’ Comm. (In re Pac. Lumber Co.), 584 F.3d 229 (5th Cir. 2009); Resorts Int’l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394 (9th Cir. 1995); Landsing Diversified Props. Il v. First Nat’l Bank and Tr. Co. of Tulsa 12 (In re W. Real Estate Fund, Inc.), 922 F.2d 592 (10th Cir. 1990).
5. See Pac. Lumber Co., 584 F.3d at 253-54.
