Restructuring

We’ve written extensively here, here, and here on the issue of third-party releases in chapter 11 plans.  Widespread interest in third-party releases appeared to reach peak status in 2021 with the high-profile nature and broad impact of several recent chapter 11 cases of multi-billion dollar companies, including those wrestling with opioid fallout like Purdue Pharma.

Encapsulating the current zeitgeist on nonconsensual third-party releases is the 142-page decision and order recently issued by Judge Colleen McMahon of the Southern District of New York, which vacated on appeal Purdue’s much-publicized confirmation order.  The District Court held that the Bankruptcy Code did not provide the Bankruptcy Court statutory authority to grant nonconsensual releases in Purdue’s chapter 11 plan of direct claims against non-debtors, including members of the Sackler family (the long-time owners of Purdue) and other affiliates of Purdue.  In so doing, the District Court canvassed the inconsistent approaches to the issue of nonconsensual third-party releases adopted across federal circuit courts and concluded that existing Second Circuit case law¹, which was widely interpreted as having left open a path in bankruptcy for approval of such releases in “rare” or “unique” circumstances, did not actually address the fundamental issue of whether statutory authority exists to approve such releases.  The District Court’s decision, which addresses the issue head-on, appears to foreclose any path to approval of nonconsensual third-party releases of direct claims against non-debtors in the Purdue bankruptcy case and upends the conventional understanding of applicable law in the Second Circuit.  Purdue has stated that it plans to appeal the decision to the Second Circuit.

The Bankruptcy Court Approves the Plan and Its Releases over Objections

Seeking reprieve from the thousands of lawsuits filed against it on account of its opioid painkiller OxyContin, Purdue filed for chapter 11 in September 2019.  After two years of extensive negotiations, multiple settlements and hard-fought litigation, Purdue finally confirmed a plan of reorganization with the consensus of over 95% of its voting creditors that included a release of certain direct claims by third parties against non-debtor Sackler family members and other non-debtor affiliates.  These included claims for willful misconduct, corporate fraud, and misrepresentation, as well as claims asserted against directors and officers by certain states for violation of unfair trade practices and consumer protection laws governing the sale of OxyContin.  In exchange for these releases, the Sacklers agreed to contribute approximately $4.5 billion to fund charities and the opioid trusts under the plan.  Eight states and the District of Columbia, among others, voted against the plan and objected to the releases.  After several days of heavily-contested hearings and revisions to the scope of the releases, the Bankruptcy Court approved the plan and the releases, overruling the remaining objections.  Subsequently, certain objectors appealed the confirmation order.

The District Court Vacates the Confirmation Order

Before delving into the District Court’s reasoning, it is worth noting that the decision’s holding focuses on direct claims against non-debtors, which are claims based upon a “particularized” injury to a third party that can be directly traced to a non-debtor’s conduct, rather than derivative claims, which are claims that relate to injury to the corporation itself.  Additionally, although the District Court held the Bankruptcy Court had subject matter jurisdiction to issue third-party releases, the heart of the decision turned on whether the Bankruptcy Code provided statutory authority to grant nonconsensual third-party releases of direct claims.  The District Court concluded it did not—“not in its express text (which [was] conceded); not in its silence (which [was] 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.”  Notably, although the District Court held that the Bankruptcy Court lacked constitutional authority to enter a final order approving the releases, the District Court did not address the other release arguments briefed, including various constitutional challenges to the nonconsensual third-party releases and whether they should be approved on the facts of the particular case, finding the lack of statutory authority to approve the releases dispositive.

The Bankruptcy Court provided six different bases to support its decision to approve the releases: sections 105(a), 1123(a)(5) & (b)(6), and 1129(a)(1) of the Bankruptcy Code, the absence of anything to the contrary in the Bankruptcy Code, and the Bankruptcy Court’s “residual authority” to issue this type of release.  The District Court addressed each in turn, discounting them and ultimately found no authority for the type of third-party releases provided for in the plan.

Section 105(a) grants the Bankruptcy Court authority to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”  Purdue argued that money from the Sacklers was necessary to carry out the plan, and that absent a release, the Sacklers would not have contributed anything to the estate.  However, the District Court determined that any exercise of section 105(a), at least within the Second Circuit, must attach to another specific provision within the Bankruptcy Code and could not be an independent source of authority.

Section 1123(a)(5) provides that a plan shall “provide adequate means for the plan’s implementation.”  However, none of the options presented by section 1123(a)(5), which involve the debtor’s assets, confers any right to release a non-debtor from particularized third-party claims in exchange for their contribution to the estate.  Therefore, the District Court held this section does not grant authority on its own, or in combination with section 105(a), for the third-party release.

Section 1123(b)(6) provides that a plan may “include any other appropriate provisions not inconsistent with the applicable provisions of this title.”  The District Court considered this section analogous to section 105(a).  Thus, if section 105(a) cannot provide independent authority to grant the third-party releases sought in the Purdue plan, then neither can section 1123(b)(6).  The District Court further determined that granting a release of claims for fraud and civil penalties payable to and for the benefit of governmental units against a third party, when such claims could not be discharged against a debtor, was inconsistent with the Bankruptcy Code.

Section 1129(a)(1) addresses one of the requirements for confirmation of a plan, and provides that a plan shall be confirmed only if it “complies with the applicable provisions of this title.”  The District Court found that section 1129(a)(1) confers no substantive rights of its own.  Therefore, section 1129(a)(1), either alone or in combination with section 105(a), could not be relied upon to authorize the third-party releases sought by the Sacklers and Purdue.

The District Court then addressed the argument that the silence of the Bankruptcy Code on the issue of nonconsensual third-party releases is in fact a source of authority supporting the releases.  The District Court presented four reasons why this argument is insufficient.  First, the District Court reasoned that silence is inconsistent with the longstanding notion that the Bankruptcy Code is comprehensive.  “Comprehensive,” the District Court explained, means “complete.”  Therefore, reading extraordinary powers into the Bankruptcy Code where it is silent cannot jibe with the understanding that the Bankruptcy Code is comprehensive.  Second, the District Court determined that Congress intended to help debtors, while not extending the benefits of the Bankruptcy Code to anyone else, and therefore it would have been unnecessary to forbid an action that benefits third parties.  Third, the District Court found that Congress did speak on this issue when it passed sections 524(g) and (h)—the Bankruptcy Code sections that provide the exact type of release sought by Purdue but only in asbestos cases.  The District Court reasoned that by authorizing releases pursuant to section 524(g), Congress was creating an exception to the default Bankruptcy Code structure.  Fourth, the District Court held that the canon of statutory interpretation that the “specific governs the general” means that because Congress had addressed the exact issue of third-party releases in section 524 and had chosen to limit the remedy exclusively to asbestos cases, a broader reading is not available.

Finding no authority in the Bankruptcy Code to support the non-debtor releases, and finding that Congressional silence in this matter was not a source of authority, the District Court turned to whether “residual authority” exists to authorize such releases.  It noted that the Sixth and Seventh Circuits have concluded that sections 105(a) and 1123(b)(6), read together, provide the Bankruptcy Court with “residual authority” that allows it to impose the type of non-consensual releases sought in the Purdue plan.  The District Court dismissed this reasoning, however, finding that the non-debtor releases in the plan are in fact inconsistent with sections 524(g) and (h), section 523, and section 1141(d) and possibly even with section 524(e) of the Bankruptcy Code, and therefore no residual authority can authorize them.

Takeaways

The District Court’s opinion was an open invitation to the Second Circuit to issue further guidance on whether nonconsensual third-party releases of direct claims against non-debtors can be authorized in a plan.  Although it is clear that Purdue intends to appeal the District Court’s opinion, it is not clear when and how the Second Circuit will take up the District Court’s invitation.  Until then, the decision is a reminder that the scope of a court’s authority to approve nonconsensual third-party releases of direct claims against non-debtors in a plan is an unsettled issue, and parties should keep a watchful eye out to see whether the District Court’s decision has broader implications for other pending and future cases.  Stay tuned for further updates as developments unfold.