The following is a case update written by Leonard Gumport analyzing a recent case of interest:
On September 17, 2021, in In re Purdue Pharma L.P., 2021 Bankr. LEXIS 2555 (Bankr. S.D.N.Y. 2021) (“Purdue 1”), United States Bankruptcy Judge Robert Drain confirmed the twelfth amended joint reorganization plan (“Plan”) of debtors Purdue Pharma, L.P. (“Purdue”), its general partner Purdue Pharma, Inc., and Purdue’s 22 wholly-owned subsidiaries (collectively, “Debtors”). The Plan included non-consensual releases of creditors’ direct claims against non-debtor entities, including certain Sackler family members (the “Sacklers”).
The confirmation order was appealed by the United States Trustee (“UST”), eight states (California, Connecticut, Delaware, Maryland, Oregon, Rhode Island, Vermont, and Washington), the District of Columbia, certain Canadian entities, and five pro se individuals (collectively, “Appellants”).
On December 16, 2021, in In re Purdue Pharma, L.P., 2021 U.S. Dist. LEXIS 242236 (S.D.N.Y. 2021) (“Purdue 2”), United States District Judge Colleen McMahon vacated the confirmation order. In a 142-page opinion, Judge McMahon decided that the Bankruptcy Code did not authorize the Plan’s non-consensual releases of Appellants’ direct claims against the Sacklers and other non-debtors. Id. at *133. Judge McMahon did not decide the validity of the creditors’ direct claims, which are strongly disputed by the Sacklers.
A copy of Purdue 2 can be found here.
On December 17, 2021, Purdue posted on its website: “Contrary to more than thirty years of governing precedent approving third party releases in appropriate circumstances, the District Court held that third party releases are never authorized by the Bankruptcy Code outside of the asbestos context.” Purdue stated that it will appeal “while simultaneously continuing its efforts to forge yet further consensus around a Plan that will deliver billions of dollars to the American people for opioid abatement.”
Purdue is a Delaware limited partnership headquartered in Stamford, Connecticut. Purdue is Debtors’ main operating entity. Debtors manufacture, sell, or distribute pain medications, including OxyContin, a prescription synthetic opioid analgesic. Purdue’s wholly-owned subsidiaries are located in the United States (“USA”) and British Virgin Islands. Purdue 2, at *33-34, 38. Purdue is owned by a Delaware limited partnership named Pharmaceutical Research Associates L.P. (“PRA”). It is indirectly 99.5% owned by trusts set up for the benefit of the Sacklers. Separately from Purdue, the Sacklers indirectly own foreign companies (the “IACs”) that distribute OxyContin and other medications outside the USA. See id. at *33-34.
In 2007, as part of a plea agreement with the USA, a Purdue affiliate named Purdue Frederick Company, Inc. (“Purdue Frederick”) pleaded guilty to one felony count of misbranding OxyContin as less addictive than it actually was. As part of the plea agreement, Purdue Frederick agreed to pay over $600 million in fines and various other payments, including payments to federal and state government agencies. See id. at *54-58, 61; United States v. Purdue Frederick Company, Inc., No. 1:07-cr-00029 (W.D. Va.); United States v. Purdue Frederick Co., 495 F.Supp.2d 569, 570-571 (W.D. Va. 2007).
During 2008-2017, Purdue distributed approximately $10.4 billion to or for the benefit of the Sacklers, of which approximately $4.6 billion went to pay pass-through taxes on Purdue’s income. Purdue 2, at *74-79. By early 2019, no Sacklers remained on Purdue’s board. By mid-2019, 49 states had filed lawsuits against Purdue, and all of these lawsuits named as defendants one or more Sacklers or related entities. Claims by the eight states who became appellants (the “State Appellants”) included claims for fraudulent transfer, fraud, unjust enrichment, negligence, public nuisance, and violation of state consumer protection statutes for deceptive and unfair acts and practices. Id. at *58, 65-70.
On September 15, 2019, Debtors filed chapter 11 petitions in the White Plains Division of the U.S. Bankruptcy Court for the Southern District of New York. Id. at at *21; see In re Purdue Pharma, L.P., No. 7:19-bk-234649-RDD. At the time, Debtors were named in more than 2,000 lawsuits, and Sackler family members were named in at least 400 lawsuits (collectively, the “Pending Actions”). Purdue 2 at *86-87; see Dunaway v. Purdue Pharm. L.P. (In re Purdue Pharm. L.P.), 619 B.R. 38, 41 (S.D.N.Y. 2020) (“Dunaway”).
On September 16, 2019, in the Bankruptcy Court, Debtors filed a brief entitled “Debtors’ Informational Brief,” in which Purdue represented: “Purdue accepted responsibility for the misconduct in 2007 and has since then strived never to repeat it.” Debtors’ Info. Br., p. 32; see Purdue 2, at *58.
On September 18, 2019, Debtors filed an adversary proceeding (the “Adversary Proceeding”) to temporarily stay the Pending Actions (by then totaling more than 2,900 lawsuits) against certain non-debtor entities (collectively, the “Related Parties”), including the Sacklers. See Purdue Pharma L.P. v. Commonwealth of Massachusetts et al., Adv. No. 19-08289-RDD; Purdue 2, at *86-88; Dunaway, 619 B.R. at 41-43. On November 6, 2019, the Bankruptcy Court granted Debtors’ motion for an order (the “Preliminary Injunction”) that temporarily enjoined all of the governmental and private plaintiffs in the Pending Actions from continuing them or commencing new actions against the Related Parties. On August 11, 2020, in Dunaway, Judge McMahon affirmed the Preliminary Injunction. During 2019-2021, the Bankruptcy Court extended the Preliminary Injunction. Id. at *71, 87-88, and 93.
On February 3, 2020, the Bankruptcy Court set a bar date of June 30, 2020 for filing of proofs of claim. Over 614,000 claimants filed proofs of claims, many of them unliquidated. Just 10% of the claims totaled $140 trillion. Claimants included the USA, states, local governments, Native American tribes, hospitals, and others, including more than 130,000 personal injury claimants. Id. at *92.
On November 24, 2020, in a plea agreement with the USA, Purdue pleaded guilty to three felonies, including a dual-count conspiracy charge of conspiring to defraud the USA, in violation of 18 U.S.C. § 371, and to violate the Food, Drug, and Cosmetic Act, in violation of 21 U.S.C. §§ 331, 331(a)(1), and 353. In the plea agreement, Purdue stipulated that its misconduct began in 2007 and continued until 2017. The plea agreement (to which the Sacklers were not parties) included a stipulation by Purdue that, according to the District Court, “chronicles Purdue’s extensive violation of the 2007 Plea Agreement, which began almost from the time the ink was dry on the papers.” Purdue 2, at *61; see USA v. Purdue Pharma L.P., No. 2:20-cr-01028-MCA (D.N.J.).
On March 15, 2021, Debtors filed their proposed plan and disclosure statement, which included a term sheet for a settlement with the Sacklers. The term sheet provided that the Sacklers would pay $4.275 billion (later raised to $4.325 billion) over nine years in return for releases from Debtors and their creditors. Purdue 2, at *98-100. On June 3, 2021, the Bankruptcy Court approved Debtors’ amended disclosure statement (“Disclosure Statement”) and authorized Purdue to solicit votes on Debtors’ fifth amended plan. See Purdue 2, at *109.
Approximately 20% of Purdue’s 614,000 creditors cast ballots on Debtors’ proposed plan. Of the creditors who voted, approximately 95% voted for the plan. See id. at *101, 116-117. During July 2021, Appellants and others objected to the plan. Among other things, the objectors argued that the non-consensual releases in the plan were unconstitutional, were not authorized by the Bankruptcy Code, and violated the State Appellants’ sovereignty. Id. at *109-110.
In August 2021, the Bankruptcy Court conducted a six-day confirmation hearing at which testimony was received (by declaration or live testimony) from 41 witnesses. By then, Debtors’ amended plan incorporated a proposed “Shareholder Settlement Agreement” for the release of claims, including creditors’ OxyContin-related claims against the Sacklers and 1,000 related entities (collectively, the “Shareholder Released Parties”). In return, the Sacklers agreed, among other things, to pay $4.325 billion over nine years and to contribute $175 million in charitable assets. The Sacklers also agreed to relinquish their ownership of Purdue, valued at approximately $2 billion by Debtors in the Disclosure Statement. Debtors’ plan provided for the transfer of their assets to creditor trusts to provide funding to abate the opioid crisis and to pay personal injury claimants. Debtors also agreed to create a public records depository containing millions of documents. See id. at *101-109.
On September 17, 2021, the Bankruptcy Court confirmed Debtors’ twelfth amended plan (i.e., the Plan), overruled objections to the non-consensual releases in Section 10.7 of the Plan, and approved the Shareholder Settlement Agreement. Id. at *110-132. In approving that settlement, Judge Drain stated that he had “expected a higher settlement,” and that “This is a bitter result. B-I-T-T-E-R.” Id. at *121. Judge Drain also approved the settlement of Debtors’ claims against the Shareholder Released Parties, including Debtors’ bankruptcy estates’ claims for breach of fiduciary duty and fraudulent conveyance arising out of the ’ upstreaming of more than $10 billion from Debtors to or for the benefit of the Sacklers after 2007. Id. at *113.
The UST and State Appellants sought stays pending appeal. In opposition, Debtors represented that they would not contend that the appeals were equitably moot during December 2021 or prior to Purdue’s criminal sentencing. After receiving those assurances, the Bankruptcy Court and the District Court denied the stay motions.
On December 1, the District Court authorized supplemental briefing on the issue of whether the non-consensual releases in the Plan were abusive in light of Debtors’ upstreaming of funds in the decade preceding their bankruptcy. On December 16, in Purdue 2, the District Court vacated the confirmation order on the ground that the Bankruptcy Code did not authorize the non-consensual releases of creditors’ direct claims against non-debtors, including the Sacklers.
On December 17, Purdue stated that it will appeal the District Court’s decision. On December 29, the Bankruptcy Court granted Debtors’ motion to extend the Preliminary Injunction to February 1, 2022. On December 30. 2021, Debtors and others filed motions requesting the District Court to certify its December 16th order for interlocutory appeals to the United States Court of Appeals for the Second Circuit. On January 3, 2022, the District Court stated that it plans to rule on those motions by Friday, January 6, 2022.
In Purdue 2, the District Court decided: (1) the Bankruptcy Court had subject matter jurisdiction of Appellants’ direct claims against non-debtors; (2) the Bankruptcy Court lacked constitutional authority to enter a final judgment granting non-consensual releases of those direct claims; and (3) the Bankruptcy Code did not authorize the non-consensual releases of Appellants’ direct claims against the Sacklers and other non-debtors.
First: The District Court decided that the Bankruptcy Court had subject matter jurisdiction. Under SPV OSUS Ltd. v. UBS, 882 F.3d 333, 339-340 (2d Cir. 2018), a bankruptcy court has broad “related to” jurisdiction over any civil proceedings that might have any conceivable effect on the bankruptcy estate. Purdue 2, at *132-133. Pursuit by creditors of their claims against the Sacklers might adversely impact all parties’ recoveries under the Plan. Creditors’ direct claims against the Sacklers were highly interconnected with derivative claims belonging to Debtors’ estates. Creditors’ pursuit of their direct claims against the Sacklers might burden Purdue by requiring it to litigate the question of Purdue’s indemnification, contribution, or insurance obligations with regard to those claims. Because Appellants’ direct claims against the Sacklers conceivably might have an impact on Debtors’ estates, the Bankruptcy Court had subject matter jurisdiction of those claims. Id. at *144-160.
Second: The District Court decided that the Bankruptcy Court’s decision was subject to de novo review because the Bankruptcy Court lacked constitutional authority to enter a final judgment releasing Appellants’ direct claims. Under Stern v. Marshall, 564 U.S. 462 (2011), a bankruptcy court lacks constitutional authority to enter a final judgment in a proceeding where, as here, there is only “related to” subject matter jurisdiction, unless all parties consent. An order granting a non-consensual release (and enjoining enforcement) of an objecting creditor’s claim is a final judgment for purposes of Stern. Inserting the releases in the Plan did not alter this conclusion. Under Stern, the test is whether the third-party claims released and enjoined by the Bankruptcy Court either stemmed from the bankruptcy itself or would necessarily be resolved in the claims allowance process. Purdue 2, at *135-143.
Appellants’ direct claims against the Sacklers did not stem from Debtors’ bankruptcy and could not be resolved in the claims allowance process. Because the non-consensual releases (and related injunction) in the confirmation order were the equivalent of a final judgment for Stern purposes, the Bankruptcy Court erred in entering an order that granted final approval of those releases. The Bankruptcy Court’s decision should have been tendered to the District Court as proposed findings of fact and conclusions of law. As a result, the District Court applied a de novo standard of review. See Purdue 2, at *135-144.
Third: The District Court decided that the Bankruptcy Code did not authorize non-consensual releases of creditors’ direct claims against non-debtors. The District Court expressly limited its decision to non-consensual releases of creditors’ “direct/particularized” claims against non-debtors. Purdue 2, at *163.
The State Appellants had alleged direct claims against one or more of the Sacklers. Nearly all of the State Appellants had laws under which individuals who serve in certain capacities in a corporation are personally liable for their participation in certain unfair trade practices. The liability imposed by those statutes was a direct liability to the States Appellants, even though such liability might arise from facts that also supported derivative liability to Debtors’ bankruptcy estates. In contrast, claims relating to the upstreaming of Debtors’ funds to or for the benefit of the Sacklers were derivative claims that belonged to Debtors’ estates, and the releases of those claims were not challenged as beyond the power of the Bankruptcy Court. Id. at *67-70, 156, 164-166.
Statutory text, legislative history, and precedent of the Supreme Court and Second Circuit led the District Court, in a lengthy decision, to conclude that the non-consensual releases of Appellants’ direct claims against non-debtors were not authorized by the Bankruptcy Code. The District Court did not decide the merits of Appellants’ claims, which remain strongly disputed by the Sacklers.
The District Court stated: “All parties agree that one and only one section of the Bankruptcy Code expressly authorizes a bankruptcy court to enjoin third party claims against non-debtors without the consent of those parties. That section is 11 U.S.C. § 524(g), which was passed by Congress in 1994. It provides for such an injunction exclusively in cases involving injuries arising from the manufacture and sale of asbestos. And it sets out a host of conditions that must be satisfied before any such injunction can be granted[.]” Purdue 2, at *166-167.
Before 1994, in MacArthur v. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89 (2d Cir. 1988) (“Manville I”), the United States Court of Appeals for the Second Circuit affirmed an injunction barring claims against certain non-debtors in connection with the bankruptcy of an asbestos manufacturer, the Johns Manville Corporation. In affirming that “unprecedented injunction,” Manville I “did not cite to a single section of the Bankruptcy Code as authorizing entry of the injunction.” Purdue 2, at *169. After this affirmance of the injunction, “questions continued to be raised about its legality.” Ibid. Also before 1994, injunctions releasing third party claims against non-debtors were entered in non-asbestos cases. Id. at *170 (citing In re Drexel Burnham Lambert Grp., Inc., 960 F.2d 285 (2d Cir. 1992) (“Drexel”) (securities); In re A.H. Robins Co., Inc., 880 F.2d 694 (4th Cir. 1989) (medical device)).
In 1994, as part of an assortment of amendments to the Bankruptcy Code, Congress enacted Sections 524(g) and (h) of the Code and an uncodified provision (“Section 111(b)”). See Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, 108 Stat. 4106, 4113-4117. Section 524(h) validated existing third party injunctions, but only in asbestos case. Section 524(g) authorized future third party injunctions, but only in asbestos cases and only under specified conditions. In addition, the “language of the statute plainly indicates that Congress believed that Section 524(g) created an exception to what would otherwise be the applicable rule of law.” Purdue 2, at *167-168. Subsection 524(g)(4)(A)(ii) authorizes a third party injunction “[n]otwithstanding the provisions of section 524(e),” and Section 524(e) provides: “Except as provided in subsection (a)(3) of this section, discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” Id. at *167-168. Uncodified Section 111(b) provided that nothing in the 1994 amendments, including Section 524(g), “shall be construed to modify, impair, or supersede any other authority the court has to issue injunctions in connection with an order confirming a plan of reorganization.” Id. at *170-171 (quoting Pub. L. No. 103-394, §111(b)). Purdue 2 states that the House Committee on the Judiciary noted in the legislative history of the amendments that: “How the new statutory mechanism works in the asbestos area may help the Committee judge whether the concept should be extended into other areas.” Id. at *172-173 (emphasis in Purdue 2). In the 1994 amendments, in the District Court’s view, Congress “left to itself, not the courts, the task of determining whether and how to extend a rule permitting nondebtor releases ‘notwithstanding the provisions of section 524(e)’ into other areas. Id. at *173.
In addition to the text and legislative history of the 1994 amendments, the District Court considered Supreme Court and Second Circuit precedent. After 1994, in a case arising from the ongoing Manville saga, the Supreme Court stated: “We do not resolve whether a bankruptcy court, in 1986 or today, could properly enjoin claims against nondebtor insurers that are not derivative of the debtor’s wrongdoing.” Travelers Indem. Co. v. Bailey, 557 U.S. 137, 155 (2009). Other Supreme Court precedent was germane. Congress intended the Code to be “comprehensive.” Purdue 2, at *174 (quoting RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. 639, 645 (2012) (“RadLAX”)). The “traditional equitable power” of a bankruptcy court “can only be exercised within the confines of the Bankruptcy Code.” Purdue 2, at *174 (quoting Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988) (“Ahlers”)). Section 105(a) of the Code does not authorize a bankruptcy court “to ‘carry out’ the provisions of the Code’ by taking an action inconsistent with its other provisions.” Purdue 2, at *175-176 (quoting Law v. Siegel, 571 U.S. 415, 425 (2014)). The “importance of the priority system leads us to expect more than simply statutory silence if, and when, Congress were to intend a major departure.” Purdue 2, at *177 (quoting Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973, 984 (2017) (“Jevic”))f.
Citing Deutsche Bank AG, London Branch v. Metromedia Fiber Network, Inc.), 416 F.3d 136 (2d Cir. 2005) (“Metromedia”), the District Court concluded that “the Second Circuit long ago identified as questionable a court’s statutory authority” to grant non-consensual releases “outside of asbestos cases.” Purdue 2, at *161; see id. at 191. In Metromedia, the Second Circuit stated that at least two concerns justify reluctance to approve non-debtor releases. First, the only explicit statutory authority for non-debtor releases is Section 542(g), 11 U.S.C. § 524(g), which only applies to asbestos cases. The grant of authority in Section 105(a) of the Bankruptcy Code “does not allow the bankruptcy court ‘to create substantive rights that are otherwise unavailable under applicable law.’” Metromedia, 416 F.3d at 142 (quoting New England Dairies, Inc. v. Dairy Mart Convenience Stores, Inc. (In re Dairy Mart Convenience Stores, Inc.), 351 F.3d 86, 92 (2d Cir. 2003) (“Dairy Mart”)). Second, a non-debtor release “is a device that lends itself to abuse. . . In effect, it may operate as a bankruptcy discharge arranged without a filing and without the safeguards of the Code.” Metromedia, at 142. Further, “[n]o case has tolerated nondebtor releases absent the finding of circumstances that may be characterized as unique.” Ibid. In Ortiz v. Fibreboard Corp., 527 U.S. 815 (1999), the Supreme Court doubted the validity of the limited fund class action device of the type involved in the Second Circuit’s decision in Drexel. Purdue 2, at *182.The District Court characterized Second Circuit law on non-consensual releases of creditors’ direct claims as “unsettled.” Purdue 2, at *198. Of decisions from other circuits, the District Court stated: “A majority of the Circuits that have spoken to the statutory authority question either dismiss the idea that such authority exists or, as with the Second Circuit, (i) reject the notion that such authority can be found looking solely to Section 105(a) and then (ii) fail to answer the question whether such authority can be found.” Id. at *201-202.
Statutory silence did not justify construing the Code to authorize non-consensual releases of creditors’ direct claims against non-debtors. Inferring statutory authority from Congressional silence was counter-intuitive because the Code was a “comprehensive” scheme. Id. at *212-213 (citing RadLAX, 566 U.S. at 655). “Granting releases to non-debtors for claims that could not be released in favor of the debtors themselves is so far outside the scope of the Bankruptcy Code and the purposes of bankruptcy that the ‘silence does not necessarily mean consent’ principle applies with equal force.” Purdue 2, at *214 (citing Jevic, 137 S. Ct. at 984). The Code was intended to free debtors from their personal obligations while ensuring that no one else reaped a similar benefit. Purdue 2, at *214. In enacting Sections 524(g) and (h), Congress “declined to make this extraordinary form of relief – relief that ran counter to the fundamental purpose of the Bankruptcy Code – available in circumstances other than asbestos cases.” Id. at *216. The Congressional silence that “speaks volumes” was Congress’s unbroken silence in the past 27 years about extending Section 524(g) to non-asbestos cases. The specific provisions of Section 524(g) strongly suggested that the general/specific canon of statutory interpretation should apply. Id. at *218 (citing RadLAX, 566 U.S. at 640).
The releases in the Plan did not carve out creditors’ claims against non-debtors for fraud or willful and malicious conduct. “Reading the Bankruptcy Code as authorizing a bankruptcy court to discharge a non-debtor from fraud liability – something it is strictly forbidden from doing for a debtor – cannot be squared with the fact that Congress intended that the Bankruptcy Code ‘ensure that all debts arising out of fraud are excepted from discharge no matter what their form.’” Id. at *204 (quoting Archer v. Warner, 538 U.S. 314, 321 (2003)). Similarly, certain of the claims asserted by the State Appellants were civil penalties payable to governmental units and would not be dischargeable if the Sacklers had filed for personal bankruptcy. Purdue 2, at *205 (citing 11 U.S.C. § 523(a)(7)).
None of the Code sections cited by the Bankruptcy Court in Purdue 1 authorized the non-consensual releases in the Plan. The Bankruptcy Court was “quite explicit” that the statutory provisions authorizing non-consensual releases were Sections 105(a), 1123(a)(5) and (b)(6), and 1129. Purdue 2, at *202-203. Those sections of the Code do not provide that they authorize non-consensual releases. For example, Section 1123(b)(6) provides that a plan may “include any other appropriate provision not inconsistent with the applicable provisions of this title.” Section 1123(b(6) is “substantively analogous” to Section 105(a). Id. at *202-203. In Dairy Mart, the Second Circuit “definitively rejected the argument that § 105(a) of the Bankruptcy Code . . . could ‘create substantive rights that are otherwise unavailable under applicable law.’” Id. at *185 (quoting Dairy Mart, 351 F.3d at 92).
In Purdue 1, the Bankruptcy Court invoked its “residual authority” to authorize the non-consensual releases. Purdue 2, at *202. The Bankruptcy Court did not have residual authority to grant non-consensual releases of creditors’ direct claims against non-debtors. “[S]uch power, if it even exists, is of no help where, as here, it is being exercised in contravention of specific provisions of the Bankruptcy Code.” Purdue 2, at *221. In addition, the traditional equitable power of a bankruptcy court “can only be exercised within the confines of the Bankruptcy Code.’” Id. at *223 (quoting Ahlers, 485 U.S. at 206). Although Debtors relied on In re Energy Resources Co., 495 U.S. 545 (1990), that case recognized that any residual power of a bankruptcy court must be exercised in a way that is not inconsistent with the Bankruptcy Code. The District Court stated: “I have become convinced, for the reasons discussed in great detail above, that the Section 10.7 non-debtor releases are in fact inconsistent with applicable provisions of title 11 – with Sections 524(g) and (h), with Section 523, and with Section 1141(d), and possibly even with Section 524(e). Therefore, no residual power can authorize such an order.” Purdue 2, at *224.
The District Court rejected the Debtors’ channeling argument. Under the Plan, all enjoined claims against the Shareholder Released Parties were to be channeled to trusts funded from Debtors’ assets and the proceeds of the Shareholder Settlement Agreement. Purdue 2, at *102-107. Although the claims against Shareholder Released Parties were purportedly channeled, they “are effectively extinguished for nothing,” because the Plan documents “expressly prohibit value being paid based on causes of action (whether pre- or post-petition) against the Sackler family or other non-debtors for opioid-related claims.” Id. at *107-109.
The District Court stated that its decision “leaves on the table a number of critically important issues that were briefed and argued on appeal,” including whether the non-consensual releases “can or should be approved on the peculiar facts of this case, assuming all the other legal challenges to their validity were resolved in Debtors’ favor. Id. at *235.
Instead of deciding the appeals on what the District Court called their “peculiar facts,” the District Court provided legal guidance on when non-consensual releases are permissible. See Purdue 2, at *235. The District Court explained: “It should not be left to debtors and their creditors to guess whether such releases are statutorily authorized; and it most certainly should not be the case that their availability, or lack of same, should be a function of where a bankruptcy filing is made.” Id. at *227.
A takeaway from Purdue 2 is that non-consensual releases of creditors’ direct claims against non-debtors are especially problematic when the claims are for liabilities, such as fraud, that Congress has said are nondischargeable. See Purdue 2, at *204-205. In enacting the nondischargeability provisions of the Code, “Congress evidently concluded that the creditors’ interest in recovering full payment of debts in these categories outweighed the debtors’ interest in a complete fresh start.” Grogan v. Garner, 498 U.S. 279, 287 (1991). In 2005, Congress amended Section 1141(d) of the Code to restrict corporate debtors from discharging their liability to domestic governmental units for fraud of the type specified in Sections 523(a)(2)(A) and (2)(B) of the Code. See Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, § 708, 119 Stat. 23, 126 (adding material to be codified at 11 U.S.C. § 1141(d)(6)(A)); see also United States v. Fusion Connect, Inc. (In re Fusion Connect, Inc.), 2021 U.S. Dist. LEXIS 167103 (S.D.N.Y. 2021) (penalty owed to FCC and traceable to corporate debtor’s fraud was excepted by Section 1141(d)(6) from discharge in chapter 11).
Purdue 2 only limits non-consensual releases of creditors’ direct claims against non-debtors. Purdue 2 does not prohibit non-consensual releases of creditors’ derivative claims. Purdue 2 did not doubt the authority of the Bankruptcy Court under Sections 363(b)(1) and 1123(b)(3)(A) of the Bankruptcy Code to release claims belonging to Debtors’ bankruptcy estates, which included (strongly disputed) fraudulent transfer claims against the Sacklers for the $10 billion upstreamed to them or for their benefit during the decade prior to Debtors’ bankruptcy filings. Section 1123(b)(3)(A) of the Code expressly authorizes “the settlement of any claim or interest belonging to the debtor or to the estate.” Section 363(b)(1) of the Code provides the “substantive basis for releasing” bankruptcy estate claims. In re Astria Health, 623 B.R. 793, 800 n.23 (Bankr. E.D. Wash. 2021) (“Astria Health”).
Purdue 2 states that the Ninth Court is one of three circuits that “reject entirely the notion that a court can authorize non-debtor releases outside the asbestos context.” Purdue 2, at *198-199 (citing, inter alia, Resorts Int’l v. Lowenschuss (In re Lowenschuss), 67 F.3d. 1394 (9th Cir. 1995) (“Lowenschuss”)). Those circuits reason that non-debtor releases are prohibited by Section 524(e) of the Code. In Lowenschuss, the Ninth Circuitstated: “This court has repeatedly held, without exception, that § 524(e) precludes bankruptcy courts from discharging the liabilities of non-debtors.” Id., 67 F.3d at 1401 (citing, inter alia, American Hardwoods, Inc. v. Deutsche Credit Corp. (In re American Hardwoods, Inc.), 885 F.2d 621, 626 (9th Cir. 1989) (“American Hardwoods”)).
In Blixseth v. Credit Suisse, 961 F.3d 1074 (9th Cir. 2020), the Ninth Circuit clarified that Section 524(e) does not prohibit a bankruptcy court from approving a chapter 11 plan’s exculpation clause that does not release the exculpated party from pre-petition claims or post-petition claims for willful misconduct or gross negligence. See id., 961 F.3d at 1083-1084 (“But Underhill [v. Royal, 769 F.2d 1426 (9th Cir. 1985)], American Hardwoods, and Lowenschuss all involved sweeping nondebtor releases from creditors’ claims on the debts discharged in the bankruptcy, not releases of participants in the plan development and approval process for actions taken during those processes.”). The exculpation clause in Blixseth did not provide “an unauthorized ‘fresh start’ to a non-debtor.” Id. at 1084. Instead, the clause dealt “only with the highly litigious nature of Chapter 11 bankruptcy proceedings.” Id. (footnote omitted). The exculpation clause was authorized by Sections 105(a) and 1123, which gave the bankruptcy court “authority to approve an exculpation clause intended to trim subsequent litigation over acts taken during the bankruptcy proceedings and so render the Plan viable.” Ibid. The clause expressly provided that it did not “release or exculpate any Exculpated Party from willful misconduct or gross negligence” as determined by a final order. Id. at 1079.
Section 1123(b)(6) of the Code authorizes a plan to “include any other appropriate provision not inconsistent with the applicable provisions of this title.” In Purdue 2, the District Court decided that Section 1123(b)(6) “is substantively analogous” to Section 105(a) and does not confer any substantive rights. Id. at *203. The language of Sections 105(a) and 1123(b)(6) is not identical. Section 105(a) authorizes a bankruptcy court to issue any order “necessary or appropriate to carry out the provisions of this title.” Section 1123(b(6) authorizes a plan to include “any other appropriate provision not inconsistent with the applicable provisions of this title.” To the extent a plan injunction is predicated on Section 105(a), its “carry out” restriction applies. In Astria Health, United States Bankruptcy Judge Whitman Holt stated that Section 1123(b)(6) “invites creativity in drafting a plan and allows bankruptcy professionals to tailor a plan to the specific needs of the case so long as the plan terms are not inconsistent with specific provisions elsewhere in the Bankruptcy Code. Id. at 797-798 (footnote omitted). The non-debtor releases in the plan in Astria Health, however, were “entirely consensual under any framework.” Id. at 803.
The District Court simplified its task by limiting its ruling to creditors’ direct claims against non-debtors. By definition, creditors’ “direct/particularized” claims against non-debtors will rarely be property of a debtor’s bankruptcy estate, unless they are creditors’ avoidance claims that the Code expressly authorizes the trustee or DIP to exercise under Section 544(b) of the Code. Permitting a bankruptcy estate to release (or compromise) claims that do not belong to the estate (and that have not been voluntarily assigned to the estate) is in tension with the Code, which specifies what property belongs to an estate and those instances where the estate is entitled to exercise the avoiding powers of creditors. As a result, the Supreme Court’s Jevic decision supports the District Court’s analysis, although Jevic only deals with the Code’s priority scheme. Purdue 2’s description of the Bankruptcy Code as “comprehensive” may not be compelling to those bankruptcy judges and practitioners who routinely must deal with applicable non-Code law in bankruptcy cases. The analysis in Purdue 2 relies in part on legislative history materials, which some judges, including multiple members of the Supreme Court, are reluctant to use in construing statutes. The detailed historical analysis in Purdue 2 will be useful to any judge or practitioner attempting to make sense of the case law on non-consensual releases of creditors’ claims. The Ninth Circuit decisions in American Hardwoods and Lowenschuss lacked the in-depth analysis of Purdue 2. Because the Code does not expressly prohibit non-consensual releases in chapter 11 plans, their validity will continue to be litigated in forums where the issue remains unresolved. Judge McMahon acknowledged: “This opinion will not be the last word on the subject, nor should it be.” Purdue 2, at *30.
These materials were written by Leonard L. Gumport of Gumport Law Firm, PC in Pasadena (email@example.com). Editorial contributions were provided the Honorable Meredith A. Jury, United States Bankruptcy Judge (ret.) (firstname.lastname@example.org).