In re Purdue Pharma L.P.: S.D.N.Y. Holds Bankruptcy Court Lacks Statutory Authority to Approve Sackler Family Releases
On December 16, 2021, in a significant decision, the United States District Court for the Southern District of New York (the “District Court”) vacated the order confirming the chapter 11 plan of Purdue Pharma L.P. (“Purdue”) and its debtor affiliates.1 In doing so, District Judge Colleen McMahon’s opinion places in substantial doubt a key element of complex in-court restructurings in the Second Circuit: non-consensual releases of direct claims against non-debtors.2
The United States courts of appeals are divided as to whether a bankruptcy court has statutory authority to release non-debtors from liability or enjoin objecting stakeholders from asserting direct (non-derivative) claims against such non-debtors. The precedent in the Fourth, Sixth, Seventh, and Eleventh Circuits is that non-consensual third-party releases may be permissible in limited and appropriate/unusual circumstances.3 The Third Circuit has concluded that a bankruptcy court has the constitutional authority to release certain third-party claims by a confirming a chapter 11 plan, but has not directly spoken on the issue of whether such releases are authorized by the United States Bankruptcy Code (the “Bankruptcy Code”) itself.4 The precedent in the Fifth, Ninth, and Tenth Circuits is that non-consensual third-party releases are not permitted by the Bankruptcy Code.5
In practice, it has been assumed that the Second Circuit permitted non-consensual third-party releases based on seminal cases such as Drexel6 and Metromedia.7 However, after a careful and thorough discussion of the leading cases and their procedural and historical context, in In re Purdue, Judge McMahon concluded that the Second Circuit has not spoken directly on the issue and did not find any statutory basis for permitting third-party releases of non-derivative claims. Following that conclusion, she observes the conflict among the Circuit Courts and the need to obtain uniformity on this key issue of liability management.8
In 2007, Purdue admitted by way of a plea agreement that it falsely marketed OxyContin, a “controlled-release semisynthetic opioid analgesic” drug manufactured by Purdue, as non-addictive and had submitted false reimbursement claims to the federal government. By 2019, Purdue was the subject of thousands of lawsuits brought by persons or estates of persons who had either become addicted to OxyContin or overdosed, either on OxyContin or other drugs for which Oxycontin served as a gateway drug. It also faced new federal, state, and local Medicare reimbursement claims and new false marketing claims brought under various state consumer protection laws. In November 2020, Purdue pled guilty to a criminal information filed by the Department of Justice in the United States District Court for the District of New Jersey whereby Purdue admitted to deliberate wrongful conduct.
After the 2007 plea agreement, Purdue’s profits were driven almost exclusively by its aggressive marketing of OxyContin. The Sackler family — the owners of Purdue — began the process of withdrawing unprecedented10 amounts of money from Purdue, over half of which was either invested in offshore companies owned by the Sacklers or deposited into spendthrift trusts. In the months before Purdue filed for bankruptcy, Purdue, the Sackler family, and the Sackler entities began discussions surrounding a potential settlement of all claims against Purdue and the Sacklers and using the bankruptcy process to release all claims against the Sacklers in exchange for their contribution of funding to a settlement. In September 2019, Purdue and certain of its affiliates filed chapter 11 bankruptcy intending to resolve both existing and future claims against the company arising from the prescription of OxyContin. By way of the automatic stay, civil litigation against Purdue came to a halt. And thanks to a court-ordered extension of the automatic stay to non-debtor affiliates of Purdue, litigation against certain members of the Sackler family was also abated during the pendency of the bankruptcy cases.
Two years into the case, Purdue proposed a chapter 11 plan that included, among other things, the funding of billions of dollars from the Sacklers in exchange for the comprehensive resolution of both private and public claims against the Sackler family, while funding opioid relief and education programs to the public at large. The plan was approved by a supermajority of actual votes cast by members of each class of creditors — but not by the objecting creditors. Judge Robert D. Drain, bankruptcy judge in the United States Bankruptcy Court for Southern District of New York (the “Bankruptcy Court”), confirmed the plan over the objections of various stakeholders who objected to the broad releases in favor of the Sackler family and their affiliates and related entities (none of whom is a debtor in the bankruptcy case) of direct claims — including claims premised on fraud, misrepresentation, and willful misconduct of those released persons under various state consumer protection statutes. The plan extinguished all civil claims against the Sacklers that related in any way to the operations of Purdue, including claims on which certain members of the Sackler family could be held personally liable to entities other than Purdue. Judge Drain concluded, inter alia, that he had the requisite statutory authority under sections 105(a),11 1123(a)(5),12 1123(b)(6),13 and 112914 to approve the releases at issue.
The District Court Opinion
Certain of the objectors15 appealed the Bankruptcy Court’s confirmation order to the District Court for the Southern District of New York. On appeal, the issues included whether a bankruptcy court is statutorily authorized to grant non-consensual releases of direct (non-derivative) claims by third parties against non-debtors in connection with the confirmation of a chapter 11 bankruptcy plan. After examination of the relevant text of the Bankruptcy Code, the District Court concluded that the Bankruptcy Code, in its express terms, by its silence, and by a purported grant of “residual authority,” does not authorize such non-consensual, non-debtor releases, and therefore the Bankruptcy Court lacked statutory authority to impose the shareholder release contemplated by the Purdue plan. Specifically, the District Court held that each of the sections cited by the Bankruptcy Court confers on a bankruptcy court only the power to enter orders that carry out other, substantive and explicit provisions of the Bankruptcy Code, and that none of them create any substantive rights that authorizes the action taken by the Bankruptcy Court.
The District Court began its discussion with a survey of the relevant case law acknowledging the widespread use of third-party releases, including in the Second Circuit. Notably, the Bankruptcy Court concluded that, contrary to the premises for the common practice in the Second Circuit bankruptcy bar, the law in the Second Circuit is unsettled on the issue, and held that the Bankruptcy Court’s reliance on Metromedia and other cases was inappropriate, stating:
So to summarize [Metromedia]: No third-party releases were approved in Metromedia. The Court of Appeals did not conclude that such releases were consistent with or authorized by the Bankruptcy Code. It did not conclude that the case before it was one of the “unique” instances in which a court’s reluctance to approve such releases might (assuming they were authorized) be overcome. And it did not decide whether the [non-debtor] releases measured up to the level that must justify approving them if the case qualified as “unique.”
In other words, while Metromedia said a great deal, the case did not hold much of anything. In its relevance, for present purposes, is that Judge Jacobs cautioned that statutory authority for non-consensual non-debtor releases outside of the asbestos context was at best uncertain — and then disposed of the case on other grounds [(mootness)], without identifying what section or sections of the Bankruptcy Code might actually authorize such relief in non-asbestos bankruptcy.
No subsequent Second Circuit case has filled in the blank.
As to the District Court’s analysis of the express terms of the Bankruptcy Code, the District Court addressed the sections cited by the Bankruptcy Court. The District Court analogized section 1123(b)(6) to section 105(a)’s authorization of “any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]” and determined that if section 105(a) does not confer any substantive authority on the Bankruptcy Court, then section 1123(b)(6) cannot be read to confer such authority either.16 Concerning section 1123(a)(5), the District Court reasoned that (1) the release of claims against non-debtors falls outside the scope of section 1123(a)(5) and (2) section 1123(a)(5) does not authorize a bankruptcy court to approve something simply because doing so would ensure funding for a plan; that is, “the mere fact that the money is being used to fund implementation of the plan does [not] give a bankruptcy court statutory authority to enter an otherwise impermissible order in order to obtain that funding.” Finally, the District Court also determined that section 1129(a)(1), like the cited sections of 1123, confers no substantive right that could be used to substantiate the release of claims against non-debtors.
The District Court also addressed the Debtors’ argument that the requisite statutory authority could be inferred from congressional silence.17 The District Court rejected this argument reasoning that (1) inferring from silence is inconsistent with the notion that the Bankruptcy Code is a comprehensive federal system that governs “the orderly conduct of debtors’ affairs and creditors’ rights”18 and to confer rights based on silence would undermine its completeness;19 (2) inferring consent from silence in circumstances when one would expect Congress to speak is counterintuitive; (3) Congress has spoken on the subject of non-debtor releases, and what it has said suggests that it intended section 524(g) [explicitly authorizing releases in cases involving asbestos] and (h) to preempt the field where non-debtor releases were concerned; and (4) debtors seek to apply general provisions (i.e., sections 105(a) and 1123(a)(5) and (b)(6)) to justify expanding the express authority conferred by Congress under section 524(g) into a situation that is not contemplated by that statute and such application violates principles of statutory instruction which require that specific provisions trump general provisions.
Finally, as to the issue of “residual statutory authority,” the District Court concluded that such authority does not exist because there is nothing in the Bankruptcy Code that specifically authorizes the releases contemplated by the plan and that the Bankruptcy Court is effectively being asked to insert a right that does not appear in the Bankruptcy Code in order to achieve a bankruptcy objective — an outcome that is prohibited by In re Dairy Mart20 and Metromedia.
Summary of Key Takeaways
Third-party releases are frequently a subject of controversy, most recently in the wake of their use in the Purdue bankruptcy case and other bankruptcy cases involving the resolution of non-asbestos mass tort litigation because of the concern that the third parties demanding such releases can shed otherwise personal liabilities (even those related to fraud and willful misconduct) in exchange for financial contributions. Indeed, the District Court noted that third-party releases have become a common practice in chapter 11 cases “based solely on the contention that anybody who makes a contribution to the case has earned a third-party release.”21 In many cases, these financial contributions have material impacts on creditor recoveries — in fact, this is one reason that cases can simultaneously have significant stakeholder support while involving extensive litigation regarding the validity of the releases included in the chapter 11 plan.
Judge McMahon’s decision has already begun to influence jurists in other jurisdictions. On December 20, 2021, four days after Judge McMahon rendered the Purdue decision, District Judge David Novack in the Eastern District of Virginia heard oral argument challenging the release and exculpation provisions contained in the Ascena Retail Group, Inc.22 debtors’ confirmed liquidating plan. According to public sources, Judge Novack, citing Judge McMahon’s decision, indicated that he is inclined to strike the third-party releases at issue, although they were described as “consensual” and criticized what he viewed as the common application of arguable “unique” facts to justify such releases. We anticipate the legality of third-party releases may end up at the Supreme Court (absent Congressional interception) to resolve the competing tension between releases of non-debtors and potential paths to maximizing value to a debtors’ estate and recoveries to creditors.
1 In re Purdue Pharma L.P., No. 7:21-cv-08566-CM, 2021 WL 5979108 (S.D.N.Y Dec. 16, 2021).
2 Unless otherwise noted herein, all references to third-party claims and the release thereof refer to direct (non-derivative claims) against such third parties. Judge McMahon described direct claims as “claims  based upon a ‘particularized’ injury to a third party that can be directly traced to a non-debtor’s conduct” as opposed to claims that would render a person liable because of the debtor’s actions or conduct. Id. at *48.
3 In re A.H. Robins Co., Inc., 880 F.2d 694 (4th Cir. 1989) (explaining that a release was acceptable where (1) release was essential to the plan because without the releases, the debtor faced potential exposure for future indemnification claims; (2) the mass tort claimants would be fully compensated as provided for in the plan; and (3) 94.38% of claimants voted to accept the plan); In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002) (enumerating seven factors for courts to consider in determining whether to approve third-party releases: whether (1) there is an identity of interests between the debtor and the third party; (2) the nondebtor has contributed substantial assets to the reorganization; (3) the injunction is essential to reorganization; (4) the impacted class, or classes, has overwhelmingly voted to accept the plan; (5) the plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction; (6) the plan provides an opportunity for those claimants who choose not to settle to recover in full; and (7) the bankruptcy court made specific factual findings); Airadigm Commc’ns, Inc. v. FCC (In re Airadigm Commc’ns, Inc.), 519 F.3d 640 (7th Cir. 2008) (“Ultimately, whether a release is ‘appropriate’ for the reorganization is fact intensive and depends on the nature of the reorganization. Given the facts of this case, we are satisfied that the release was necessary for the reorganization and appropriately tailored.”); SE Prop. Holdings, LLC v. Seaside Eng’g & Surveying, Inc. (In re Seaside Eng’g & Surveying, Inc.), 780 F.3d 1070 (11th Cir. 2015) (concluding that the bankruptcy court did not abuse discretion when analyzing the Dow Corning factors for purposes of determining whether nonconsensual third-party releases were appropriate).
4 In re Millennium Lab Holdings II, LLC, 945 F.3d 126, 133–40 (3d Cir. 2019) (concluding the nonconsensual third-party releases and injunctions contained in the proposed reorganization plan were “integral to the restructuring of the debtor-creditor relationship,” and so the bankruptcy court had constitutional authority to confirm the plan).
5 See, e.g., Ad Hoc Grp. of Vitro Noteholders v. Vitro S.A.B. de C.V. (In re Vitro S.A.B. de C.V.), 701 F.3d 1031, 1061–63 (5th Cir. 2012) (restating its opposition to non-debtor releases in the context of a chapter 15 case); Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm. (In re Pac. Lumber Co.), 584 F.3d 229 (5th Cir. 2009) (concluding that non-debtor releases are inappropriate outside the context of asbestos cases); Resorts Int’l v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394 (9th Cir. 1995), cert. denied, 517 U.S. 1243 (1996) (“This court has repeatedly held, without exception, that § 524(e) precludes bankruptcy courts from discharging the liabilities of non-debtors.” (citations omitted)); In re W. Real Estate Fund, Inc., 922 F.2d 592, 601–02 (10th Cir. 1990) (concluding “the stay may not be extended post-confirmation in the form of a permanent injunction that effectively relieves the nondebtor from its own liability to the creditor”).
6 In re Drexel Burnham Lambert Grp., Inc., 960 F.2d 285 (2d Cir. 1992).
7 Deutsche Bank v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136, 142 (2d Cir. 2005).
8 In re Purdue Pharma, 2021 WL 5979108, at *4, 47 (“This opinion will not be the last word on the subject, nor should it be. This issue has hovered over bankruptcy law for thirty-five years — ever since Congress added §§ 524(g) and (h) to the Bankruptcy Code. It must be put to rest sometime; at least in this Circuit, it should be put to rest now.”)(“There is long-standing conflict among the Circuits that have ruled on the question, which gives rise to the anomaly that whether a bankruptcy court can bar third parties from asserting non-derivative claim[s] against a non-debtor — a matter that surely ought to be uniform throughout the country — is entirely a function of where the debtor files bankruptcy.”).
9 The following factual findings were made by the Bankruptcy Court and accepted by the District Court.
10 During the period of 2008–2016, Purdue up-streamed on average 53%, and as much as 70%, of its revenues to the Sacklers. By way of comparison, during the period of 1996–2007, Purdue up-streamed on average 9% of its revenue per year to the Sacklers. It also jumped from distributing approximately 38% of its free cash flow in 2006 to distributing 167.4% of free cash flow in 2007 and continued to distribute free cash flow in the 90% range for the next decade. These distributions totaled approximately $10.4 billion.
11 “The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. . . .” 11 U.S.C. § 105(a).
12 “Notwithstanding any otherwise applicable nonbankruptcy law, a plan shall . . . provide adequate means for the plan’s implementation . . . .” 11 U.S.C. § 1123(a)(5).
13 “[A] plan may . . . include any other appropriate provision not inconsistent with the applicable provisions of this title.” 11 U.S.C. § 1123(b)(6).
14 Section 1129 requires that a court confirm a plan if certain enumerated requirements are met.
15 The objectors included, among others, the United States Trustee, as well as the states of California, Connecticut, Delaware, Maryland, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia.
16 The District Court also noted that, notwithstanding this proposition, the releases at issue are inconsistent with the Bankruptcy Code for at least two reasons. First, because the releases discharge a non-debtor from debts that Congress specifically said could not be discharged by a debtor in bankruptcy and that “[r]eading the Bankruptcy Code as authorizing a bankruptcy court to discharge a non-debtor from fraud liability — something it is strictly forbidden from doing for a debtor — cannot be squared with the fact that Congress intended that the Bankruptcy Code ‘ensure that all debts arising out of fraud are excepted from discharge no matter what their form.’” In re Purdue Pharma, 2021 WL 5979108, at *48 (citing Archer v. Warner, 538 U.S. 314, 321 (2003)). Second, some of the claims asserted by appellants representing state governments constituted non-dischargeable civil penalties payable to and for the benefit of governmental units and therefore such claims could not be discharged under section 523(a)(7) if the Sacklers had filed for personal bankruptcy.
17 As the court noted, the legislative history of section 524(g) indicates that Congress explicitly assigned to itself, and not the courts, the task of determining whether and how to permit non-debtor releases outside of the asbestos context.
18 E. Equip. & Servs. Corp. v. Factory Point Nat. Bank, Bennington, 236 F.3d 117, 120 (2d Cir. 2001).
19 Cf. Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973, 986 (2017) (“The importance of the priority system leads us to expect more than simple statutory silence if, and when, Congress were to intend a major departure.” (citing Whitman v. American Trucking Assns., Inc., 531 U.S. 457, 468 (2001) (“Congress . . . does not, one might say, hide elephants in mouseholes”))).
20 New England Dairies, Inc. v. Dairy Mart Convenience Stores, Inc. (In re Dairy Mart Conveniences Stores), 351 F. 3d 86, 92 (2d Cir. 2003).
21 Indeed, in July 2021, Senator Elizabeth Warren and others introduced the Nondebtor Release Prohibition Act of 2021 (S. 2497), which would add a new section 113 to the Bankruptcy Code prohibiting the use of third-party releases absent express written consent by each individual releasing creditor, and providing such consent or non-consent cannot justify different treatment for such creditor.
22 No. 20-33113-KRH (Bankr. E.D. Va. filed July 23, 2020).
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