Restructuring

Executive Summary

The distinction between a prepetition claim and a postpetition claim¹ can lose clarity when prepetition acts set in motion a postpetition harm. Judge John Dorsey recently addressed this distinction in the context of antitrust claims in In re Mallinckrodt PLC,² with potential implications for other types of postpetition claims. In Mallinckrodt, the Bankruptcy Court found that creditors (health insurers) held postpetition claims for their postpetition purchases of one of the debtor’s (Mallinckrodt’s) prescription drugs at allegedly supracompetitive prices, even though certain alleged unlawful acts that led to, and created liability for, the inflated price occurred prepetition. The Court’s decision, which came in response to a summary judgment claim objection brought by the debtor, thus permitted the insurers to continue to pursue administrative expense claims for their postpetition purchases.

Not only did this decision potentially elevate the insurers’ payment priority for a potentially substantial (over $300 million) claim, it led the Court to delay the debtor’s scheduled confirmation trial until after it issues a ruling on whether the postpetition antitrust claims should (i) be allowed under applicable antitrust law and (ii) receive administrative expense status—two issues that were not determined in the Court’s narrow summary judgment ruling that the claims were postpetition, not prepetition, claims. As of the writing of this post, the Court has heard arguments from the insurers and the debtor on the validity of the insurers’ antitrust claims and whether those claims qualify for administrative expense status under the Bankruptcy Code but has not issued any decision.

Legal Background

Administrative expense claims are entitled to payment ahead of unsecured claims and must be paid in full to confirm a chapter 11 plan. To qualify as an administrative expense claim under section 503(b)(1)(A) of the Bankruptcy Code, a claim must be both (i) a postpetition claim and (ii) an “actual, necessary cost[] and expense[] of preserving the [debtor’s] estate.”

Under Third Circuit case law, the timing of a claim (i.e., when a claim arises) depends on when a person is exposed to the debtor’s product or conduct giving rise to an injury, even though the claim may not “accrue” until the injury and right to payment take place.^[3] Thus, if a creditor’s exposure to the debtor’s conduct occurs prepetition, the claim is a prepetition claim. If the creditor’s exposure occurs postpetition, the claim is a postpetition claim.

Additionally, in Reading Co. v. Brown, 391 U.S. 471 (1968), the Supreme Court held that a postpetition tort committed by the debtor within the scope of its business is entitled to administrative expense priority under section 503(b)(1)(A). This is known as the Reading doctrine.

Factual Background

The debtor, Mallinckrodt, is a pharmaceutical company. It produces, among other things, a prescription drug called Acthar. It also produces opioids. The debtor filed for chapter 11 because of liabilities related to its opioid production. At the same time, however, the debtor has been mired in antitrust litigation over its sale of Acthar, including from health insurers alleging it charged, and the health insurers paid, supracompetitive prices.

According to the insurers, the debtor’s anticompetitive activity began prepetition, when the debtor acquired and shelved a competitive drug and used other improper marketing techniques to raise Acthar’s price—a price the debtor continued charging postpetition. The insurers asserted an administrative expense claim for their postpetition purchases of Acthar under Reading.⁴

The debtor countered that it had cured any alleged anticompetitive activity prepetition, when it granted another company a license to produce the rival drug and increased its compliance efforts regarding the alleged improper marketing. The debtor further contended that charging a high price alone is not an antitrust violation. Because all potentially unlawful conduct occurred prepetition, it argued, the insurers’ claims for postpetition purchases were merely prepetition claims that manifested postpetition, not new injuries. Thus, Reading did not apply and the claims could not receive administrative expense priority.

Both parties argued public policy favored their position. The debtor argued that the “fresh start” provided by chapter 11 permitted it to charge whatever price it wanted for Acthar postpetition, while the insurers argued that such a result would provide immunity for illegal prepetition conduct.

The crux of the question before the Bankruptcy Court was therefore whether postpetition payments of a supracompetitive price are postpetition claims, when certain alleged unlawful actions that led to the higher price took place prepetition.

Legal Analysis

The Bankruptcy Court held that, assuming the insurers could prove their claims, the insurers held postpetition claims and could continue to pursue administrative expense priority.

The Court began by restating and affirming the Third Circuit case law referenced above regarding when a claim arises. Applying this test to the Mallinckrodt facts, the Court held that the insurers’ claims arose postpetition upon the sale of Acthar, because that was “when the claimants were exposed to the [debtor’s] product/conduct.”⁵ By coincidence, the claim also happened to accrue at the same time. Accordingly, the insurers had a postpetition claim for their postpetition purchases.

Along with holding that the insurers had a postpetition claim, the Court also rejected the debtor’s argument that, because monopolistic pricing is not by itself anticompetitive conduct, postpetition sales at inflated prices cannot, as a matter of law, constitute continuing violations of the antitrust laws. Rejecting the debtor’s position, the Court reasoned that each postpetition sale was an “overt act” in furtherance of an illegal course of conduct and thus could constitute a repeated and continuing antitrust violation, giving rise to new injury, even if the course of conduct began prepetition. In so holding, the Court distinguished another case dealing with antitrust claims in bankruptcy, In re Travel Agent Commission Antitrust Litigation, 583 F.3d 896 (6th Cir. 2009). In that case, the Sixth Circuit found that the debtor’s post-confirmation decision to maintain a 0% commission payment to the plaintiffs, allegedly in line with a prepetition price-fixing conspiracy, was not a new, overt act but rather the effect of an earlier overt act (the initial decision to not pay a commission).⁶ As a result, the plaintiffs held only prepetition claims, which were discharged pursuant to the debtor’s confirmed plan of reorganization.

Finally, the Court found public policy favored allowing the insurers to continue pursuing their administrative expense claim for the alleged postpetition antitrust violations. The Court reasoned that the “fresh start” of the Bankruptcy Code had its limits. Specifically, it could not be used as both a sword and shield to permit a debtor to escape the mass litigation for prepetition liability, but then, postpetition, engage in continuing violations of law against captive creditors without liability. In other words, a debtor should not be able to build a monopoly illegally prepetition and then profit off that monopoly without liability postpetition.

Takeaways

As mass tort and other litigation cases proliferate in bankruptcy, plaintiffs and defendants should keep in mind the lessons of Mallinckrodt. The timing of claims can have a huge impact on relative creditor recoveries and even on the debtor’s prospect of a successful reorganization—too high administrative expense claims may make it more difficult for a debtor to exit chapter 11. Paramount to this timing inquiry is the point of exposure to a postpetition tort, which may not necessarily be the first act that sets a chain of consequences in action, especially if a debtor’s affirmative acts (such as a sale) continue postpetition. And in all cases, debtors should be aware that just because providing a debtor with a “fresh start” is a key objective of the Bankruptcy Code, courts will not necessarily turn a blind eye to illegal prepetition conduct that sets in motion illegally-obtained postpetition gains. Rather, debtors must comply with the law postpetition and post-Effective Date to avoid liability.

Update: On December 6, 2021, the Bankruptcy Court sustained the debtor’s objection to the insurers’ postpetition antitrust claims, finding that Acthar’s high price did not result from illegal activity and that regulatory hurdles, rather than the debtor’s behavior, prevented a rival drug from being released. Thus, although the insurers won the battle (the issue of whether their claims were postpetition), they lost the war (the merits of whether their claims would be allowed against the debtor).