Court unravels Purdue bankruptcy plan protecting Sacklers

In a recent appellate decision vacating Purdue Pharma's confirmed chapter 11 bankruptcy plan of reorganization, the U.S. District Court for the Southern District of New York addressed an issue that "has hovered over bankruptcy law for thirty-five years." In re Purdue Pharma, L.P., 2021 U.S. Dist. LEXIS 242236 (S.D.N.Y. December 16, 2021). The court identified the "great unsettled question" as whether a bankruptcy court (or any other court) has statutory authority to grant nonconsensual releases of third-party claims against nondebtors. The court explained that, while one would think that this had been long ago settled, it has not been, stating "[t]here is a 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 [a] nonderivative claim against a non-debtor -- a matter that surely ought to be uniform throughout the country -- is entirely a function of where the debtor files for bankruptcy."

Purdue chose to file its bankruptcy case in the White Plains location of the Bankruptcy Court for the Southern District of New York because there is just one bankruptcy judge in that location and it liked its chances with that judge. On November 22, 2021, following negative publicity flowing from the bankruptcy court's ruling on the plan in the Purdue case, the Bankruptcy Court for Southern District of New York announced that going forward large chapter 11 cases will be assigned on a random basis to the bankruptcy judges of the district irrespective of the courthouse in which the case is filed.

A plan of reorganization is generally the vehicle for achieving the goal of rehabilitation of the debtor under chapter 11 of the Bankruptcy Code. Confirmation (approval) of a chapter 11 plan binds the debtor, any entity acquiring property under the plan, creditors, and equity security holders of the debtor. 11 U.S.C. Section 1141(a). Subject to certain limited exceptions, confirmation discharges a debtor from pre-confirmation claims and such obligations are replaced by the obligations under the plan. Id. Section 1141(d). The plan is, in effect, a new court-sanctioned contract between the reorganized debtor, its creditors, and other parties to the plan. Complications and controversy arise where, as in Purdue, the plan is used to accomplish a nonconsensual discharge of claims held by third parties against parties who are not the debtor in the bankruptcy case.

As the district court described, "[e]ngulfed in a veritable tsunami of litigation, Purdue filed for chapter 11 bankruptcy in September 2019. The intent was for a 'Manville-style' bankruptcy that would resolve both existing and future claims against the company arising from the prescription of OxyContin." As a result of the bankruptcy filing, an automatic stay halted all litigation against Purdue. 11 U.S.C. Section 362. Further, the bankruptcy court entered and repeatedly extended a preliminary injunction, in effect, expanding the automatic stay to halt litigation against certain nondebtors affiliated with the company. The beneficiaries of these special injunctions were primarily members of the Sackler family, which had long owned Purdue. Then, as characterized by the district court, "[f]or two years, committees of various classes of creditors -- individuals, state and local governments, indigenous North American tribes, even representatives of unborn children who were destined to suffer from opioid addiction -- negotiated with Purdue and the Sacklers under the watchful eye of the experienced Bankruptcy Judge, with the assistance of two of this country's finest and most experienced mediators."

The negotiations eventually resulted in a plan of reorganization for Purdue that the district court said "would, if implemented, afford billions of dollars for the resolution of both private and public claims, while funding opioid relief and education programs that could provide tremendous benefit to the consuming public at large." Under the plan, in return for obtaining nonconsensual third-party releases, the Sacklers agreed to contribute $4.5 billion. The plan was approved by a supermajority of votes cast by the members of each class of creditors. The bankruptcy judge confirmed the plan and, as described by the district court, "had invested so much of himself in the effort to find a workable solution to a seemingly intractable problem." Various parties, including eight states and the District of Columbia, certain tribes, and a few individual personal injury claimants, filed formal objections to the plan and appealed its confirmation. In negative reaction to the bankruptcy court's confirmation of the plan, legislation known as the "Nondebtor Release Prohibition Act of 2021" has been introduced in Congress.

Between 2008 and 2017, the Sacklers pulled $10.4 billion out of the company, substantially reducing Purdue's "solvency cushion." Much of the money was either transferred to offshore entities controlled by the Sacklers or deposited into spendthrift trusts that could not be reached in bankruptcy. All of the appellants, according to the district court, objected to the plan's "broad releases, not just of derivative, but of particularized or direct claims -- including claims predicated on fraud, misrepresentation, and willful misconduct under various state consumer protection -- to the members of the Sackler family (none of whom is a debtor in the bankruptcy case) and to their affiliates and related entities." Moreover, these claims could not be discharged if the Sacklers were themselves debtors in bankruptcy.

The district court emphasized that the U.S. Supreme Court "has never specifically considered whether the nonconsensual release of non-derivative claims asserted by third parties against non-debtors can be approved in the context of a debtor's bankruptcy." The district court, however, took guidance from Supreme Court decisions framing the contours of the Bankruptcy Code and limiting the powers of bankruptcy courts. The district court cited RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. 639, 645 (2012), for the principle that the Bankruptcy Code is intended to be comprehensive. It cited Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988), for the proposition that the bankruptcy court's traditional equity powers can only be exercised within the confines of the Bankruptcy Code. The district court relied on Law v. Siegel, 571 U.S. 415 (2014), and Czyzewski v. Jevic Holdings Corp., 137 S. Ct. 973 (2017), for the precept "that a bankruptcy court lacks the power to award relief that varies or exceeds the protections contained in the Bankruptcy Code -- not even in 'rare' cases, and not even when those orders would help facilitate a particular reorganization."

Next, turning to the case law in the 2nd U.S. Circuit Court of Appeals where the Purdue case is pending, the court found that the issue of statutory authority to release and enjoin the prosecution of third-party claims against nondebtors, is unsettled, except in asbestos cases, where statutory authority is clear and exists under Bankruptcy Code Section 524(g). Addressing the law of the other circuits, the district court discussed that (1) the 5th, 9th and 10th Circuits completely reject that a court can authorize nondebtor releases outside the asbestos context, (2) the 3rd Circuit, while not identifying any statutory authority, has held that bankruptcy courts have constitutional authority to extinguish certain third-party claims by confirming a chapter 11 plan, (3) the 4th and 11th Circuits have concluded that section 105(a) of the Bankruptcy Code authorizes such releases, (4) the 6th and 7th Circuits have concluded that bankruptcy courts have "residual authority" to grant the releases, and (5) the 1st, 8th and D.C. Circuits have yet to weigh in on the question.

In Blixseth v. Credit Suisse, 961 F.3d 1074 (9th Cir. 2020), the 9th Circuit upheld the release of a creditor from liability for certain claims under an exculpation clause contained in a chapter 11 plan. The 9th Circuit emphasized the narrow nature of the releases and distinguished its prior decisions rejecting nondebtor releases. Unlike "sweeping nondebtor releases from creditors' claims on the debts discharged in the bankruptcy," the more limited releases at issue involved "releases of participants in the plan development and approval process for actions taken during those processes."

The Purdue district court rejected the view that the releases at issue could be justified as unique and upheld as necessary in "rare cases." The court concluded that "the Bankruptcy Code does not authorize such nonconsensual 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. For that reason, the Confirmation Order ... must be vacated." The district court noted that its "opinion will not be the last word on the subject, nor should it be" and emphasized that "the lower courts desperately need a clear answer." 