By Jeffrey C. Toole, Esq.
Bankruptcy Partner
Cleveland Office
On December 16, 2021, Judge Colleen McMahon of the United States District Court for the Southern District of New York sent shock waves rippling nationwide. She overturned an order of the United States Bankruptcy Court in her district that had “confirmed” (approved) a Chapter 11 plan of reorganization filed by Purdue Pharma, L.P., and associated entities (collectively, “Purdue”), the maker and marketer of the opioid known as OxyContin. Purdue’s plan would have forever insulated non-debtors affiliated with Purdue, primarily members of the Sackler family (the “Sacklers” or “Sackler family”), from answering for creditors’ existing and future causes of action against them connected with OxyContin and other opioids. In exchange for being released from such causes of action, the Sackler family would have contributed more than $4 billion to help fund distributions to creditors under Purdue’s plan. The plan, however, would have made the releases binding upon creditors—whether they consented to release the Sackler family or not.
Judge McMahon explained that the “great unsettled [legal] question” is whether “any court . . . is statutorily authorized to grant such releases”—at least, to the extent they are “non-consensual.” The federal Courts of Appeals disagree on this question; the Second Circuit (which includes New York) “has not yet analyzed the issue,” even though it “identified the question” almost 20 years ago. Judge McMahon wrote that “[t]his will no longer do.” “Either statutory authority exists or it does not. . . . Moreover, the lower courts are desperately in need of an answer.”
In her decision, Judge McMahon unequivocally expressed her view: “[T]he Bankruptcy Code does not authorize such non-consensual non-debtor releases; not in its express text (which is conceded); not in its silence (which is disputed); and not in any section or sections of the Bankruptcy Code that, read singly or together, purport to confer generalized or ‘residual’ powers on a court sitting in bankruptcy.” Judge McMahon vacated the bankruptcy court’s order confirming Pharma’s plan, upending a multi-billion dollar settlement that had been in the making since before Pharma’s bankruptcy began.
Some Background on the Non-Consensual Release Issue
In Chapter 11 bankruptcies—especially those involving thousands of “mass tort” personal injury lawsuits—it has become common for plans of reorganization to include provisions that release non-debtors from personal injury creditors’ (and other creditors’) claims, even though those non-debtors are not themselves in bankruptcy. The non-debtors typically include the bankrupt business’s present and former officers, directors, owners, and insurers, among others. In exchange for receiving an expansive release in a plan, the non-debtors usually agree to “contribute” money or other property to help fund distributions to the creditors upon whom the plan imposes the releases.
Such releases often cover creditors’ “derivative claims” – i.e., claims that seek to recover on the basis of the bankrupt debtor’s conduct, rather than for the non-debtor’s own conduct. Derivative claims relate to injury to the debtor itself. If a creditor’s claim is one that a bankruptcy trustee could bring on behalf of the debtor’s estate, then it is derivative.
Such releases also often cover creditors’ “direct claims.” Those are claims that creditors assert for their own, particularized injuries that can be traced to a non-debtor’s conduct.
In Purdue, the releases covered creditors’ derivative and direct claims against various non-debtors, including the Sackler family. On appeal to Judge McMahon, the release of creditors’ derivative claims was not at issue. Likewise, she was not asked to decide about releases of direct claims to which the affected creditors “consented” (e.g., by voting in favor of the plan).
Instead, the challengers opposed the Purdue plan’s “non-consensual” releases of their direct claims. Releases of claims are characterized as being “non-consensual” if affected creditors vote against a plan or object to it, but the plan provides that those “dissenting” creditors’ claims will be released anyway.
At present, whether a bankruptcy court has the statutory authority to approve a plan that contains such releases depends upon where the Chapter 11 case is filed, because the various federal Circuit Courts of Appeals (whose respective jurisdictions cover distinct groups of States) disagree. Judge McMahon canvassed those courts’ decisions and concluded that a majority of the Circuits that have spoken to the statutory authority question either dismiss the idea that such authority exists or (a) reject the notion that such authority can be found by looking solely to section 105(a) of the Bankruptcy Code (which authorizes a bankruptcy court to enter orders that “carry out” the provisions of the Bankruptcy Code) and then (b) do not answer the question of where such authority can be found.
Specifically, she opined that the Fifth, Ninth and Tenth Circuits “reject entirely the notion that a court can authorize non-debtor releases outside the asbestos context.” According to Judge McMahon, the Second Circuit has not yet ruled expressly on this, and “its only clear statement is that section 105(a) of the Bankruptcy Code, standing alone, does not confer such authority . . . outside the asbestos context.” The Third Circuit, she wrote, concurs with that view and thus far has overturned lower court decisions that approved non-debtor releases. On the other hand, the Fourth and Eleventh Circuits have held that section 105(a) of the Bankruptcy Code, by itself, does authorize third-party releases. Meanwhile, the Sixth and Seventh Circuits interpret sections 105(a) and 1123(b)(6) to codify bankruptcy courts’ “residual authority” to approve such releases, so long as the proposed Chapter 11 plan satisfies a list of factors. And the First, Eighth and D.C. Circuits have yet to express an opinion on the subject.
Against this jumbled backdrop, Judge McMahon evaluated the “non-consensual” releases in Purdue’s plan.
The Facts of Purdue’s Case
In her 142-page opinion, Judge McMahon explained what happened:
The Sackler family owned and controlled Purdue until shortly before the bankruptcy. Between 1996 and 2019, Purdue’s revenue totaled $34 billion. More than 90% of that revenue came from the sale of an opioid named OxyContin. As has been widely reported, an explosion of opioid addiction in the United States during the last two decades precipitated thousands of lawsuits against Purdue and, ultimately, hundreds against the Sacklers.
In a 2007 plea agreement, Purdue admitted that it had falsely marketed OxyContin as being non-addictive and had submitted false claims for reimbursement to the government for medically unnecessary opioid prescriptions. Nonetheless, after the plea agreement, Purdue’s profits “were driven almost exclusively” by aggressively marketing OxyContin.
By 2019, “Purdue was facing thousands of lawsuits brought by persons who had become addicted to OxyContin and by the estates of addicts who had overdosed—either on OxyContin itself or on the street drugs (heroin, fentanyl) for which Purdue’s product served as a feeder.” New federal, state, and local Medicare reimbursement claims, as well as new false marketing claims, also had been filed against Purdue under various state consumer protection laws.
Citing to the bankruptcy court’s findings, Judge McMahon observed that, from 2008 to 2016, the Sacklers “distributed significant sums of Purdue money to themselves,” even though they were “aware of the opioid crisis and the litigation risk.” The distributions during those years were far larger than in prior years, measured as a percentage of Purdue’s revenues. During that later period, the distributions totaled almost $10.4 billion. About $4.6 billion of that sum covered pass-through taxes. According to the Sacklers’ own expert, these withdrawals drained Purdue’s assets by 75% and its “solvency cushion” by 82%. Although they attempted to shield their assets from collection efforts, the Sacklers were at risk of being sued to return up to $11 billion they received from Purdue as “voidable transfers.”
Battling a “veritable tsunami of litigation,” Purdue and related entities filed Chapter 11 bankruptcies in September 2019. The Sacklers did not file bankruptcy themselves.
Shortly thereafter, the bankruptcy court approved a temporary injunction to bar all lawsuits against Purdue, as well as against its current and former owners, officers, directors or employees (thus including the Sacklers). Purdue argued that enjoining that litigation was necessary to facilitate the parties’ efforts to reach a global settlement in a single forum—the bankruptcy court. The injunction stopped more than 2,900 lawsuits against the company and 400 lawsuits against the Sacklers. The injunction was extended numerous times thereafter and, as noted below, was further extended after Judge McMahon’s decision.
In November 2020, while in bankruptcy, Purdue pled guilty again—this time to a criminal Information filed by the Department of Justice (“DOJ”). In its plea agreement, Purdue admitted to “substantial deliberate wrongful conduct,” according to Judge McMahon, in violation of the 2007 plea agreement. Judge McMahon wrote that the violations “began almost from the time the ink was dry” on the 2007 plea agreement.
In Purdue’s bankruptcy case, more than 600,000 creditors filed proofs of claims asserting, collectively, an eye-popping sum of damages. The deadline for filing those claims passed, though, before some of the creditors holding “direct claims” against non-debtors learned that Purdue’s Chapter 11 plan would extinguish their claims.
Purdue’s plan was a result of extensive mediation and settlement negotiations that had commenced months before the bankruptcy. The Sacklers agreed to contribute $4.325 billion over nine years to a fund that would be used to resolve both public and private civil claims as well as both civil and criminal settlements with the federal government. But the Sacklers insisted that, in exchange for agreeing to make those contributions, they must be insulated from any pending or future lawsuits.
The plan therefore included releases in favor of the Sackler family and related entities. Judge McMahon described the releases as being “broad” and as extinguishing “[a]ll present and potential claims connected with OxyContin and other opioids,” notably including “claims asserted by the states—both consenting states and the objecting states—arising under various unfair trade practices and consumer protection laws that make officers, directors and managers who are responsible for corporate misconduct personally liable for their actions.”
Those releases were non-consensual. The releases would apply to the objecting creditors, not just to the creditors who consented by voting in favor of the plan.
The plan also provided for the creation of nine trusts, into which various creditors’ claims would be “channeled” for assessment and payment.
Purdue’s creditors overwhelmingly supported the settlement. Roughly 120,000 votes were cast. Of those who voted, more than 95% accepted the plan. The plan drew approval from more than 79% of the states and territories, more than 96% of other governmental entities and tribes, and more than 96% of the personal injury claimants, together with a supermajority of all other claimants.
But not everyone approved. Several entities, including the United States Trustee (an agency of the DOJ sometimes described as a “bankruptcy watchdog”) and eight States, objected to confirmation. They opposed the plan’s non-consensual releases of their “direct” claims.
The bankruptcy judge confirmed the plan notwithstanding the objections. He found no other reasonably viable method to achieve the outcome the plan would provide. He also concluded that, if the plan were not confirmed, Purdue would end up liquidating, and unsecured creditors (including the personal injury claimants) would recover nothing. He confirmed the plan on September 17, 2021.
Numerous entities appealed the confirmation order to the District Court, including the United States Trustee, eight states, the District of Columbia, and various pro se creditors.
Judge McMahon’s Decision Vacating the Order: Confirming Purdue’s Chapter 11 Plan
On December 16, 2021, District Judge McMahon rendered her decision. She vacated the confirmation order, because she concluded that the non-consensual release of third-party creditors’ direct claims against non-debtors was not permissible.
Initially, District Judge McMahon determined that the bankruptcy court lacked the constitutional authority to approve releases of third parties’ claims against non-debtors, based upon the U.S. Supreme Court’s 2011 decision in Stern v. Marshall. Stern limits bankruptcy courts’ power, as courts established under Article I of the U.S. Constitution, to enter final orders that adjudicate claims between non-debtors if those claims “neither stem from [the debtor’s] bankruptcy nor can [] be resolved in the claims-allowance process” in a bankruptcy case. She concluded that the nonconsensual releases were “the equivalent of a final judgment for Stern purposes” that disposes of claims between non-debtors (the Sacklers and those who have sued or may sue them), as to which the bankruptcy judge lacked the authority to enter a final order without the affected creditors’ consent – and the objecting creditors did not consent. Instead, she opined, the bankruptcy judge should have tendered proposed findings and conclusions of law to the District Court for its consideration.
Judge McMahon then answered two questions raised on appeal relating to the non-consensual releases of the non-debtors:
First, she addressed whether the bankruptcy court had subject matter jurisdiction (i.e., judicial power) to impose a release of non-debtor claims. She answered “yes.” Under the law of the Second Circuit (which includes New York), the bankruptcy court has broad “related to” jurisdiction over any civil proceedings that “might have any conceivable effect” on a bankrupt debtor’s estate. She observed that the non-derivative litigation against the Sacklers might alter the liabilities and change the amount available for distribution to creditors. The claims against Purdue and against the Sackler family also have a high degree of “interconnectedness”; she wrote that courts typically associate such interconnectedness with having an effect on the estate. And the Sacklers’ potential indemnification, contribution, or insurance rights against Purdue also could implicate the estate and distributions to creditors. Consequently, because the many civil proceedings asserted against the non-debtor Sackler family members might have a conceivable impact on Purdue’s estate, the bankruptcy court has subject matter jurisdiction to approve the releases.
Second, she turned to the “dispositive” question: whether the bankruptcy court has statutory authority under the Bankruptcy Code to approve the non-debtor releases. She answered “no.” She found nothing in the Bankruptcy Code that authorizes “a bankruptcy court to order the nonconsensual release of third-party claims against non-debtors in connection with the confirmation of a Chapter 11 bankruptcy plan.” She observed that the confirmation order did not identify any provision of the Bankruptcy Code that provides such authority. Judge McMahon ruled that the sections the bankruptcy judge had relied upon, whether read individually or together, do not provide a bankruptcy court with such authority. According to Judge McMahon, those sections (sections 105(a), 1123(a)(5), (b)(6), and 1129) only empower a bankruptcy court to “enter orders that carry out other, substantive provisions of the Bankruptcy Code”—and no “other, substantive provision” of the Bankruptcy Code authorizes releases of this type. And, she concluded, no “equitable authority” or “residual authority” to approve such releases exists in a bankruptcy court, untethered to some specific, substantive grant of authority in the Bankruptcy Code (which she did not find). The Second Circuit, she observed, has not yet taken a position on this question. Other Courts of Appeals are in disagreement.
Judge McMahon identified only one Bankruptcy Code provision, section 524(g), that expressly authorizes Chapter 11 plans to enjoin third-party creditors’ claims against certain non-debtors. But section 524(g) applies only to cases involving “injuries arising from the . . . sale of asbestos,” not opioids. According to Judge McMahon, Congress’s enactment of section 524(g) indicated that it retained “the task of determining whether and how to extend a rule permitting non-debtor releases . . . into other areas.” Congress thus has not been silent on the question; instead, she suggested, it has opted to address it only in the asbestos context—at least, for now.
Finally, Judge McMahon found that no “residual authority” exists in the bankruptcy courts to approve non-consensual releases. If it did, that power would be “exercised in contravention of specific provisions of the Bankruptcy Code.” She was unwilling to “insert a right that does not appear in the Bankruptcy Code to achieve a bankruptcy objective.”
District Judge McMahon concluded that the Bankruptcy Code does not bestow upon bankruptcy courts the authority to confirm plans that non-consensually bar third-party creditors’ claims against non-debtors. Therefore, she vacated the bankruptcy judge’s order confirming Purdue’s plan.
Judge McMahon also noted that she had left a number of issues undecided that the parties had briefed and argued. Among those open issues is whether the releases “can or should be approved on the peculiar facts of [Purdue’s] case, assuming all the other legal challenges to their validity were resolvd [sic] in [Purdue’s] favor.”
So What’s Next?
Judge McMahon emphasized that the lower courts need a definitive answer regarding whether these non-consensual releases are allowed in Chapter 11 plans. On January 7, 2022, Judge McMahon authorized Purdue and the Sackler family to appeal her decision to the Court of Appeals for the Second Circuit; they have until January 17 to do so. Given the stark disagreement among the Circuits about this issue, if the Second Circuit renders a decision of its own on the merits, the issue finally might make its way to the U.S. Supreme Court.
Alternatively, Congress may provide an answer. If enacted, the “Stop shielding Assets from Corporate Known Liability by Eliminating non-debtor Releases Act” (or “SACKLER Act”), introduced in the House of Representatives on March 19, 2021 (as H.R. 2096) and in the Senate on July 26, 2021 (as S. 2472), would prohibit a bankruptcy court from releasing claims against non-debtors brought by States, federally-recognized tribes, municipalities or the federal government. On July 28, 2021, the “Nondebtor Release Prohibition Act of 2021” was introduced in the House (as H.R. 4777) and in the Senate (as S. 2947) to extend the SACKLER Act’s prohibition on releases to individuals’ claims. These Acts also would empower a bankruptcy court to issue a 90-day stay regarding such claims. Whether these Acts will be enacted and, if they are, what final form they may take remains uncertain.
For the moment, settlement discussions among the parties in Purdue’s bankruptcy case are supposed to resume. Following Judge McMahon’s decision, the bankruptcy judge extended the stay of pending and future lawsuits that he entered shortly after Purdue’s bankruptcy began, so that the parties can negotiate about whether or how to revise Purdue’s plan. The stay will expire on February 1, 2022, unless it is further extended. To facilitate those negotiations, on January 3, 2022, the bankruptcy court appointed another bankruptcy judge as a mediator, the Honorable Shelley C. Chapman, and established a procedure to accomplish the mediation, setting a January 14 deadline.
A related question, which was not raised in Purdue’s plan or addressed in Judge McMahon’s decision, is whether plan proponents can “work around” the non-consensual release issue. One method sometimes used is to give creditors the capacity to “opt-out” of granting the release (or, less frequently, to give them the capacity to “opt-in”), purportedly to transform a “non-consensual” release into a “consensual” one. This may be accomplished by including an “opt-out” or “opt-in” box for creditors to check on the ballots they use when they vote for or against a plan. This method is not a cure-all, though. The capacity to “opt-out” (or “opt-in”) does not work for creditors who do not “check the box” because they fail or decline to vote on a plan. Likewise, creditors may not realize they are being given the option, either because they do not read the documents that describe the option closely enough or because they do not understand what those documents mean. As a result, the efficacy of an “opt-out” (or “opt-in”) release also is unsettled.
Purdue Pharma is merely the latest pronouncement on the non-consensual release issue, but it will not be the last one. If they so choose, Congress or the U.S. Supreme Court will have the final say. Perhaps then the lower courts finally will have the answer Judge McMahon says that they desperately need.
