UPDATE: At midnight on March 27, 2022, certain provisions of the CARES Act expired. Importantly for insolvency practitioners, the subchapter V debt limit of $7,500,000 reverted to the lower original amount of $2,725,625. It appears that Congress is working to reinstate the higher debt limit and at least one bill has been proposed (S. 3823) and passed by the Senate on April 8, 2022, reinstating the $7,500,000 debt limit and adding language to make it effective retroactively, but with a two year expiration date. However, the status of this bill or any other efforts by Congress to increase the subchapter V debt limit remains unclear.
April 20, 2022
Dear constituency list members of the Insolvency Law Committee:
The following is a case update written by Wendy W. Smith, a partner in Binder & Malter, LLP, analyzing a recent decision of interest:
On December 16, 2021, Judge Colleen McMahon of the United States District Court, Southern District of New York, vacated the order confirming Purdue Pharma’s Chapter 11 plan of re-organization, holding that the bankruptcy court had no power to impose a non-consensual release by third parties of their direct claims against non-debtors. In re Purdue Pharma, L.P., 2021 WL 242236 (S.D.N.Y 2021). The non-debtors here included all of the Sackler family, owners of Purdue Pharma, who were to be released from virtually all non-criminal claims related to the companies and their primary product–OxyContin. In exchange for that release and the related injunctions (the “Shareholders Release”), the Sackers were to pay over $4.275 billion into the plan of reorganization.
To view the opinion, click here.
On first review, the opinion might appear as having limited impact outside the Second Circuit. But many of Judge McMahon’s arguments can apply to any situation where a bankruptcy court exercises authority that is not specifically described in the Bankruptcy Code, particularly to enjoin third parties from suing non-debtors.
The Sackler Family’s Role in Purdue Pharma and the OxyContin Litigation.
From the opening of her opinion, Judge McMahon reveals her sensitivity to the underlying issue driving the case—the catastrophic impact of the opioid crisis in America—and that her ruling will most likely result in undoing the Sackler’s funding of the proposed plan and its programs to address opioid addiction. (p. 137) Although the opinion rules only on matters of law, as no finding of fact was appealed, Judge McMahon repeatedly returns to the extreme circumstances of the case to color her legal analysis.
To provide that context, Judge McMahon devotes the first half of the opinion to the facts. She begins with the history of Purdue Pharma and its development and marketing of OxyContin, which has been blamed in large part for fueling the opioid crisis. Judge McMahon describes that before Purdue’s bankruptcy, OxyContin accounted for more than 90% of the company’s U.S. revenue. The Sackler family, which owns the companies, is described as being “long ranked on Forbes’ List of America’s Richest Families,” with a reported net worth in 2015 of $14 billion. (p.11) Judge McMahon states that the Sackler family controlled the operation of the Purdue companies until just before the bankruptcy filing.
The core of Judge McMahon’s factual description is Purdue’s aggressive, and allegedly deceptive, marketing of OxyContin for over 20 years and the resulting litigation with both governments and individuals. Most of the litigation claimed in part that Purdue’s actions caused the over-prescription of OxyContin, leading to addiction, which then resulted in addicted patients turning to street drugs when prescriptions were no longer available.
In 2007 Purdue settled litigation with 26 states, agreeing to pay $19 million and to implement an extensive program to limit OxyContin abuse. (p.21). Purdue was not required to stop the production or sale of OxyContin, however, which it continued. Litigation also continued. When the resulting discovery revealed that individual members of the Sackler family were involved with Purdue’s OxyContin marketing efforts, those individuals were added to the actions. 
After the 2007 settlement agreement, the Sacklers began taking substantially greater distributions of revenue from Purdue, which “substantively depleted Purdue’s treasury.” (p.37) Judge McMahon describes this as part of a greater plan by the Sacklers to first remove value from the companies and then use bankruptcy to obtain third-party releases in exchange for funding a bankruptcy settlement. The goal was “to secure for the Sacklers a release from any liability for past and even future opioid-related litigation, without having to pursue personal bankruptcy.” (p.43).
The Purdue companies filed their bankruptcy on September 15, 2019, and quickly obtained an injunction halting over 400 civil suits against the Sackler family.
The Plan and Shareholder Release
Judge McMahon acknowledges the extraordinary efforts of all of the parties to negotiate a plan, including mediators described by Judge McMahon as “the most experienced and respected mediators in the country.” (p. 47) .The opinion describes the plan in detail.
The Shareholders Release was a key element. In exchange for the Sackler’s $4.275 billion contribution, the plan released “third-party claims against over 1000 individuals and entities related to the Sackler family.” (p.55) The release included “claims that third parties have asserted or might assert in the future against the shareholder released parties,” and that were based on or related to the debtors or their bankruptcies. (p. 56) The release was further limited to claims where the “conduct, omission or liability of any Debtor or any Estate is the legal cause or is otherwise a legally relevant factor.” (p. 56) The Shareholders Release was non-consensual; all current and potential claims connected with OxyContin and other opioids would be covered.
Judge McMahon notes that the non-derivative claims against the released parties were “effectively being extinguished for nothing.” (p. 56) The plan prohibited “value being paid based on causes of action (whether pre-or post-petition) against the Sackler family or other non-debtor for opioid-related claims.” (p.56)
The critical element of these released claims is that they must be claims directly against the released parties arising from an independent duty to the claimant, and not derivative of any claim by or against the debtor.
Judge McMahon describes the bankruptcy judge’s opinion confirming the plan as a “judicial tour de force” delivered only days after a lengthy trial, and addressing “every conceivable legal argument in great detail.” (p.58)
The bankruptcy court’s opinion noted that the voting creditors overwhelmingly supported the plan. Of approximately 120,000 votes cast, “an amount far exceeding the voting in any other bankruptcy case” over 95% of those voting favored the plan. (p.62) It also observed that the failure to approve the settlement and confirmation would result in complex litigation and likely with the liquidation of the case and abandonment of the proposed $4.275 billion contribution by the Sacklers.
Judge McMahon briefly summarizes the various legal issues addressed by the bankruptcy court’s opinion, and then focuses on its justification for the third-party non-consensual releases. For its authority to grant the Shareholders Release, the bankruptcy court relied on the concept of its “necessary or appropriate” power to take actions under Section 105(a), combined with the authority in Section 1123(b)(6) to “include any other appropriate provision [in a plan] not inconsistent with the applicable provisions of this title.” (p. 68) The bankruptcy court also justified the grant of the Shareholders Release based on the “rare” and “unique” character of the case. (p.70)
As described below, Judge McMahon rejects these justifications.
 While mentioned only briefly in the opinion, it is important to note that the individual Sacklers have at all times denied any wrongdoing
Bankruptcy court did not have jurisdiction to enter a final order on confirmation containing the Shareholders Release.
In the context of addressing the standard of review on appeal, Judge McMahon observes that the Shareholders Release would have permanently resolved certain independent claims against the Sackler family. Because the claims did not stem from the bankruptcy itself, and would not be resolved in the claims-allowance process, the only jurisdiction held by the bankruptcy court over them was “related to” the bankruptcy under 28 U.S.C. Section 157(a), as “non-core.”
Applying the Supreme Court ruling of Stern v. Marshall, 564 U.S. 462 (2011), Judge McMahon concludes that that a non-consensual release by a third party of a claim against a non-debtor that is part of a reorganization plan determines the claim with the same finality as it would if adjudicated at trial. Judge McMahon thus holds that the bankruptcy judge did not have jurisdiction to enter a final order confirming a plan which included such third-party release. Rather, the bankruptcy court should have tendered the proposed findings of fact and conclusions of law to the District Court for approval.
Bankruptcy court had subject matter jurisdiction under the Second Circuit case-law
The appellants challenged whether the bankruptcy court’s “related to” jurisdiction included the ability to grant the challenged Shareholders Release. Judge McMahon concludes that in the Second Circuit the only question a court need ask is whether the action’s outcome might have any conceivable effect on the bankruptcy estate. If the answer is yes, then “related to” jurisdiction exists, no matter how improbable it might be that the actions actually will have an effect on the estate. (p.85)
Judge McMahon held that the bankruptcy court had “related to” jurisdiction because claims against the Sackler family could have resulted in indemnification claims against Purdue and that such claims could have impacted the bankruptcy estate.
No bankruptcy statute either prohibits such releases or grants authority to issue them
Judge McMahon opens her discussion by expressing frustration with the Second Circuit for failing to provide guidance on this critical issue. She explains that, though the Bankruptcy Code has no prohibition against these releases, it also has no statute giving bankruptcy courts the authority to grant them. Judge McMahon analyzes each of the sections on which the bankruptcy court relied and finds they are insufficient to grant such authority. Finally, she explains that there is no “residual authority” or general equitable power of the bankruptcy court that can cure the lack of specific statutory authority in the Bankruptcy Code.
Judge McMahon initially dispenses with the appellants’ argument that Section 524(e) essentially prohibits the Shareholders Release. This section provides that the discharge of a debt in bankruptcy does not affect the liability of another for the same debt. Judge McMahon explains that this section does not prohibit a bankruptcy court from issuing an injunction, but addresses only the automatic effect of a discharge. Also, the section is limited to claims that are discharged in bankruptcy for which a third-party is also liable. It does not affect independent claims of third-parties against non-debtors–the type of claim included in the Shareholders Release.
The only sections in the Bankruptcy Code that specifically address third-party releases are Sections 524(g) and (h) regarding the release of third-party claims in asbestos cases. The sections were enacted after the first of several opinions in the case of Johns Manville, the nation’s leading asbestos manufacturers. MacArthur Co. V. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89 (2nd Cir. 1988) (“Manville I”).
In Manville I, the Second Circuit affirmed the bankruptcy court’s entry of a permanent injunction against suing Manville’s insurance carriers, which had contributed the proceeds of their policies to the plan. Judge McMahon explains Sections 524(g) and (h) in detail, emphasizing that they applied to asbestos cases only. Judge McMahon argues that the limitation is evident both from the text of the statues as well as their legislative history, which expressly states that Congress was not acting regarding other industries (p. 100) Because of the limited scope of the asbestos statutes, Judge McMahon concludes that they cannot be read to imply authority to grant non-debtor releases in other types of cases.
The other Bankruptcy Code sections on which the bankruptcy court relied were Section 105(a), which provides general authority to make orders that are “necessary or appropriate to carry out the provisions of the code,” and three sections related to chapter 11 plans—Sections 1123(b)(5) and (b)(6), and 1129. The bankruptcy judge stated that the sections, along with his “residual authority,” gave him authority to approve the Shareholders Release. Judge McMahon rejects this position, holding that each of the sections “confers on the bankruptcy court only the power to enter orders that carry out other, substantive, provisions of the bankruptcy code.” (p.120)
Early in her opinion, Judge McMahon explains in detail that notwithstanding the general language of Section 105(a) it does not grant any general equitable authority. Relying on the Supreme Court opinions of Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988) and Law v. Siegel, 571 U.S. 415 (2014), as well as several cases in the Second Circuit, Judge McMahon notes 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.” (p. 101)
The sections related to chapter 11 particularly do not expand that authority. Section 1123(b)(6) describes the possible contents of a plan of reorganization and provides that it may “include any other appropriate provision not inconsistent with the applicable provisions of this title.” Judge McMahon notes that the section is substantially similar to Section 105(a) and concludes that if general authority of Section 105(a) does not allow a bankruptcy court to grant relief beyond specific terms of the Bankruptcy Code, neither does Section 1123(b)(6).
An even more general section relied on by the bankruptcy court is Section 1129(a)(1), which provides that a bankruptcy court “shall confirm a plan only if… the plan complies with the applicable provisions of this title.” Judge McMahon holds that, like Section 1123(b)(6), the section does not grant any substantive authority that could support approving this type of third-party release.
Last, Section 1123(a)(5), also relied on by the bankruptcy court, gives no greater authority. This section provides that a plan must provide adequate means for its implementation. The plan proponents argued that the only way for the debtors to obtain the funds to implement the plan was to grant the Sacklers the Shareholders Release in exchange for the money that the Sacklers were to contribute. This requirement, they argued, meant that the releases were authorized by Section 1123(a)(5) as necessary for the plan’s implementation.
Judge McMahon rejects the argument for a range of reasons, including that Section 1123(a)(5) does not authorize a court to approve such releases “simply because doing so would ensure the funding of a plan.” (p.126) She states that “the fact that Purdue needs the Sacklers to give the money back does not mean that Section1123(a)(5) confers on the Debtors or the Sacklers any right to have the non-debtors receive a release” in exchange for the contribution. (p. 125)
Silence of the Bankruptcy Code does not grant the needed authority.
Judge McMahon rejects the argument that because this type of release is not prohibited it must be permitted. First, she notes that to assume authority from silence is inconsistent with the “comprehensive federal system … to govern the orderly conduct of debtors affairs and creditors rights.” (p. 127) Second, she notes that the type of release being requested includes relieving non-debtors of the types of claims –here for fraud and willful misconduct — that could not be discharged in their own bankruptcies and thus are entirely inconsistent with the Bankruptcy Code. Third, she refers again to Sections 524(g) and (h), which were enacted to allow third-party releases only in asbestos cases, even when there were other mass tort cases pending at the time. Judge McMahon notes that Congress made a conscious decision to exclude other industries, and that its “27 years of unbroken silence” since then “speaks volumes” to Congress’s disinclination to expand the statute.
Judge McMahon’s review of case law and split in the circuits does not change her analysis.
Judge McMahon reviews the split in the Circuits regarding whether statutory authority exists to grant this type of release. She notes that the Fifth, Ninth and Tenth Circuits reject that bankruptcy court can authorize non-debtor releases outside of the asbestos context, based on Section 524(e). (As noted below, the Ninth Circuit has recently reopened this discussion in its opinion in in re Blixseth v. Credit Suisse, 961 F.3d 1074 (9th Cir. 2020).) She then comments that the remaining Circuits, including the Second, either have not identified any statute that grants such authority other than Sections 105(a) and 1123(b)(6) – which she rejects as inadequate—or have not opined on the issue.
Judge McMahon closes her discussion with an acknowledgment that the result of her invalidating the Shareholders Release will likely be the liquidation of the case and the loss of funding for “desperately need programs to counter opioid addiction.” She notes that, notwithstanding the bankruptcy court’s good intentions, its ability to grant relief to a non-debtor from non-derivative third-party claims could have only been exercised within the confines of the Bankruptcy Code. Because she finds that the Bankruptcy Code “confers no such authority” she holds she must vacate the order confirming the Purdue plan. (p. 137)
The primary takeaway from the opinion is that the mechanism of the Bankruptcy Code cannot accommodate every solution to the challenges facing a debtor and its creditors. Here, it is evident that the huge number of stakeholders in the process, and ultimately the bankruptcy court, became vested in trying to provide substantial relief–with the Sacklers’ payment–for the desperate circumstances caused by the opioid crisis. If anything, the Shareholders Release evidences the great forces driving the settlement and plan process. It released over 1,000 people and entities and included claims for fraud and willful misconduct, whether existing or brought in the future–terms that would have been rejected in any other context as overreaching.
Judge McMahon’s opinion provides powerful defenses against such excesses. First and foremost, she reaffirms that any authority of the bankruptcy court must be solidly bound to the Bankruptcy Code itself. While many cases recognize this limitation when applying Section 105(a), Judge McMahon applies it with equal force on all of the other general sections relied on by the bankruptcy court for its claim of “residual authority.”
Until recently, in the Ninth Circuit such third-party releases were not allowed at all on the basis that they were contrary to Section 524(e). In re Blixseth v. Credit Suisse 961 F.3d 1074 9th Cir. 2020) modified that rule and reopened the possibility of including such releases in a chapter 11 plan. In Blixseth, the court considered an exculpation clause in a Chapter 11 plan that released Credit Suisse, a creditor, for liability for post-petition actions “in connection with” among other things, negotiating the plan. The released claims did not include claims derived from the debtor. The court held that, contrary to prior understanding, Section 524(e) did not prohibit such third-party releases, for the same reasons described by Judge McMahon. While the releases in Bixseth included only negligence claims and were narrow in time and the number of parties, substantively, they covered the character of independent claims included in Purdue. The court in Blixseth allowed the releases. It found that both Section105(a) and Section 1123 provided the bankruptcy court with authority to impose such releases on a non-debtor, and that it was justified by the need to limit litigation and “so render the plan viable.” Supra, at p.1085. But, according to Judge McMahon, the referenced sections do not grant such authority, and “plan viability” does not justify granting a third-party release.
What is left open is whether any non-consensual third-party release of non-derivative claims against non-debtors can be approved even when it is limited to negligence claims against specific parties. Under this opinion, the answer is no, since there is no specific statute authorizing it, and neither “residual authority” nor “plan viability” will suffice.
Given the discussion and holdings in Purdue, and the recent 9th Circuit’s opinion in In re Blixseth v. Credit Suisse, the ruling on the likely Purdue appeal will be one to watch.
This review was written by Wendy W. Smith, a partner in Binder & Malter, LLP and a member of the ad hoc group. Editorial contributions were provided by Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.
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