USA June 6 2023

On May 30, 2023, the United States Court of Appeals for the Second Circuit (the “Second Circuit” or the “Court”) rendered a much anticipated opinion (the “Opinion”),1 reversing the order of the United States District Court for the Southern District of New York (the “District Court”) that the Bankruptcy Code does not permit non-consensual third-party releases of direct claims and affirming the order of the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) confirming the chapter 11 plan (the “Purdue Plan”) of Purdue Pharma L.P. (“Purdue”), which approved non-consensual third-party releases of the owners of Purdue — members of the Sackler family.

The Opinion comes on the heels of a line of recent district court opinions upholding the propriety of non-consensual third-party releases in appropriate circumstances,2 a pending appeal before the Third Circuit Court of Appeals on the third-party releases approved in the Boy Scouts of America plan,3 and pending petitions for writ of certiorari in Highland Capital seeking review by the United States Supreme Court (the “Supreme Court”) of the scope of permissible plan exculpations, and whether Bankruptcy Code § 524(e) prohibits a chapter 11 plan from exculpating or releasing non-debtors for liability as held by the Fifth Circuit and consistent with rulings of the Ninth and Tenth Circuits.4

Background and Procedural History

On December 16, 2021, the District Court vacated the Bankruptcy Court’s order confirming the Purdue Plan, which had approved a mediated settlement that included non-debtor third-party releases for the Sacklers.5 For a detailed discussion on the background and procedural history of the Purdue bankruptcy case, see In re Purdue Pharma L.P.: S.D.N.Y. Holds Bankruptcy Court Lacks Statutory Authority to Approve Sackler Family Releases, (Dec. 28, 2021).

The Opinion

At issue before the Second Circuit was: (1) whether the Bankruptcy Court had the authority to approve the Purdue Plan’s non-consensual release of direct third-party claims against the non-debtor Sacklers; and (2) whether the Bankruptcy Code, the factual record, and equitable considerations supported the Bankruptcy Court’s approval of the Purdue Plan. The Second Circuit concluded that: (1) the Bankruptcy Court had “related-to” jurisdiction to approve the releases through submission of proposed findings of fact and conclusions of law to the District Court; (2) the Bankruptcy Court had the requisite statutory authority under §§ 105(a) and 1123(b)(6) to approve the releases; and (3) the factual record supported the Bankruptcy Court’s approval of the releases under a newly pronounced seven-factor test.

Subject Matter Jurisdiction: The Second Circuit first addressed whether the Bankruptcy Court had subject matter jurisdiction to approve the releases and found that it had “related-to” jurisdiction, but it lacked constitutional authority to approve the releases on a final basis. As such, the Second Circuit agreed with the District Court’s construction of the Bankruptcy Court decision as setting forth its proposed findings of fact and conclusions of law for the District Court’s de novo review.

Statutory Authority: Expressly joining the view of the majority of circuits, the Second Circuit explained that together, §§ 105(a)6 and 1123(b)(6)7 provide the statutory equitable authority necessary to permit the Bankruptcy Court’s approval of the Purdue Plan.8 The Second Circuit rejected the view of the minority of circuits that § 524(e)9 bars non-consensual third-party releases because they impermissibly discharge non-debtors.

The Second Circuit’s Test: The Second Circuit ruled that courts should consider the following seven factors:

whether there is an identity of interests between the debtors and released third parties, including indemnification relationships, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete the assets of the estate;
whether claims against the debtor and non-debtor are factually and legally intertwined, including whether the debtors and released parties share common defenses, insurance coverage, or levels of culpability;
whether the breadth of the release is necessary to the plan;
whether the release is essential to the reorganization, in that the debtor needs the claims to be settled in order for the res to be allocated (and not because the released party is somehow manipulating the process to its own advantage10);
whether the non-debtor contributed substantial assets to the reorganization;
whether the impacted class of creditors “overwhelmingly” voted in support of the plan;11 and
whether the plan provides for fair payment of enjoined claims, with a focus on the fairness of the payment and not the final amount of the payment.
Significantly, the Court explained that “[a]lthough consideration of each factor is required, it is not necessarily sufficient — there may even be cases in which all factors are present, but the inclusion of third-party releases in a plan of reorganization should not be approved.” Moreover, “[f]or the bankruptcy court to make such findings, extensive discovery into the facts surrounding the claims against the released parties will most often be required.”

Ultimately, the Second Circuit concluded that the Bankruptcy Court did not err by approving the Purdue Plan, and the Court identified the following findings, supported “in tens of millions of documents produced in discovery,” as relevant to that approval:

the identity of interests between the Debtors and those Sacklers named as defendants in the litigations;
the factual and legal overlap between claims against Debtor and settled third-party claims;
the releases being required to ensure that the valuation of the res is settled;
the scope of the releases was limited so that the released claims related only to the Debtor’s conduct and the estate;
the res itself amounted to only approximately $1.8 billion and, without the Purdue Plan, the government would recover its $2 billion first, which would deplete the res completely and prevent any recovery by other creditors;
the impact of the financial contribution of $5.5–0 billion is one of the largest contributions to a bankruptcy anywhere in the country; and
the valuation of claims (estimated at $40 trillion) far exceeds the total funds available and the Sackler’s wealth, which created the need for the Purdue Plan’s “intricate settlements.”
Summary of Key Takeaways

The Second Circuit’s Opinion further demonstrates the split among circuits as to the validity and permissibility of third-party releases in plans of reorganization. Notably, the Court’s requirement that a bankruptcy court submit proposed findings of fact and conclusions of law to a district court for its approval where third-party releases are included may delay the plan confirmation process in certain cases. The new seven-factor test could also prove burdensome for some plan proponents seeking non-consensual third-party releases as part of a global compromise, particularly in light of the Court’s emphasis on the need for extensive discovery and particularized factual findings to support the inclusion of third-party releases in a plan. In light of the circuit split, including the different approval standards among the permissive circuits, parties may continue to experience uncertainty in seeking third-party releases in a package that otherwise delivers a complete resolution. These issues may well ultimately be addressed by the Supreme Court (as practically invited by Judge Wesley in his concurring opinion) to resolve the circuit split and adopt a uniform approach.

Vinson & Elkins LLP – Katherine Drell Grissel, Kristie Torkildsen Duchesne, David S. Meyer, Steven M. Abramowitz, Bradley Foxman, Paul E. Heath, George R. Howard, Lauren R. Kanzer, Jessica C. Peet, William L. Wallander and Steven Zundell