Purdue Pharma, L.P. v. City of Grande Prairie (In re Pharma L.P.), 69 F.4th 45 (2nd Cir. 2023)

The following is a case update written by Leonard Gumport analyzing a recent case of interest:

SUMMARY

In In re Purdue Pharma L.P., 633 B.R. 53 (Bankr. S.D.N.Y. 2021) (Purdue 1), United States Bankruptcy Judge Robert D. Drain approved the nonconsensual third-party releases in the joint chapter 11 plan (the “Plan”) of debtors Purdue Pharma L.P. (“Purdue”), Purdue Pharma Inc. (“PPI”), and Purdue’s 22 wholly-owned subsidiaries (collectively, “Debtors”). The Plan released the strongly-disputed claims of Debtors’ creditors against non-Debtors, including certain members of the Sackler family (collectively, the “Sacklers”).     

In In re Purdue Pharma, L.P., 635 B.R. 26 (S.D.N.Y. 2021) (Purdue 2), United States District Judge Colleen McMahon vacated the confirmation order and held that the Bankruptcy Code did not authorize the Plan’s releases. Debtors and others appealed. On May 30, 2023, in Purdue Pharma, L.P. v. City of Grande Prairie (In re Pharma L.P.), 69 F.4th 45 (2nd Cir. 2023) (Purdue 3), in an opinion by United States Circuit Judge Eunice C. Lee, the United States Court of Appeals for the Second Circuit reversed in relevant part and upheld the Plan’s releases. 

In Purdue 3, the Second Court decided that 11 U.S.C. §§ 105(a) and 1123(b)(6) jointly authorize confirmation of a chapter 11 plan that grants nonconsensual releases of creditors’ direct claims against third parties, provided that multiple requirements are met. By reason of controlling Second Circuit precedent, United States Circuit Judge Richard C. Wesley reluctantly concurred. Judge Wesley doubted that the Bankruptcy Code authorizes nonconsensual releases of creditor’s direct claims against third parties. Judge Wesley stated: “Regardless of the right answer, the majority’s answer pins this Circuit firmly on one side of a weighty issue that, for too long, has split the courts of appeals.” Purdue 3, at 90.

On July 28, 2023, on behalf of the United States Trustee for Region 2 (“UST”), the Solicitor General sought a stay from the United States Supreme Court. On August 10, 2023, in Case No. 23-124 (Purdue 4), the Supreme Court ruled: “The application for stay presented to Justice Sotomayor and by her referred to the Court is granted. The mandate of the United States Court of Appeals for the Second Circuit in [C]ase No. 22-110 and the consolidated cases is recalled and stayed. Applicant suggested this Court treat this application as a petition for a writ of certiorari; doing so, the petition is granted. The parties are directed to brief and argue the following question: Whether the Bankruptcy Code authorizes a court to approve, as part of a plan of reorganization under Chapter 11 of the Bankruptcy Code, a release that extinguishes claims held by nondebtors against nondebtor third parties, without the claimants’ consent.”

To read the full published decision in Purdue 3, click here.

FACTS

Purdue is a Delaware limited partnership. Purdue’s general partner is PPI, a New York corporation. PPI’s board of directors (the “Board”), manages Purdue. Pharmaceutical Research Associates, L.P. (“PRA”), owns Purdue. PRA is 99.5% owned by Delaware limited partnerships, which are owned by trusts for the family of Mortimer D. Sackler (also known as “Side A” of the Sackler family) and the family of Raymond R. Sackler (also known as “Side B” of the Sackler family). From approximately 1993 to 2018, the Board included six or seven Sacklers. Purdue 2, 635 B.R. at 39-40; see Purdue 3, at 56 n.1. 

In 1995, Purdue developed OxyContin, a controlled-release semisynthetic opioid analgesic. Also in 1995, the Food and Drug Administration (“FDA”) approved OxyContin. Its FDA-approved label reflected a low risk of addiction. During 1996-2001, Purdue aggressively marketed OxyContin while downplaying addiction concerns. Starting in 2000, States began to alert Purdue to widespread abuse of OxyContin. Lawsuits against Purdue proliferated. In 2001, the FDA required Purdue to correct OxyContin’s label. Purdue 3, at 58. 

In late 2004, the Board voted to indemnify Purdue’s directors and officers against claims made in connection with their service to Purdue. In addition, the Board approved an indemnity agreement (the “Purdue-Sackler Indemnity Agreement”), which contained an exclusion for conduct taken in bad faith. Purdue 3, at 58-59.

In 2007, Purdue Frederick Company, an affiliate of Purdue, pled guilty to one felony count of misbranding OxyContin. Purdue 2, at 47. By 2007, the Sacklers anticipated that the effects of the OxyContin-related litigation against Purdue would eventually impact them directly. During 2008-2016, Purdue distributed approximately $11 billion to Sackler family trusts and holding companies. By 2019, all Sacklers had stepped down from the Board. Purdue 3, at 58-59.

On September 15, 2019, Debtors filed chapter 11 petitions in the White Plains Division of the United States Bankruptcy Court for the Southern District of New (the “Bankruptcy Court”). The Sacklers did not file bankruptcy. Debtors’ estate had collective estimated values of approximately $1.8 billion. Claims against the Debtors were estimated at more than $40 trillion. There were nearly 3,000 actions pending against Purdue and over 400 actions against the Sacklers. During September-October 2019, in the Bankruptcy Court, Debtors sought and obtained a preliminary injunction that stayed the actions against the Sacklers. Purdue 3, at 60; Purdue 2, at 59-60.

In 2020, Purdue entered into a plea agreement with the United States Department of Justice (“DOJ”). Purdue agreed to plead guilty to violations of the federal anti-kickback statute. In addition, Purdue agreed to a forfeiture judgment of $2 billion and gave the DOJ a super-priority claim for that amount. The plea agreement stipulated that the DOJ would release $1.775 billion of its $2 billion claim if Purdue’s reorganization plan established an opioid abatement trust for the public benefit and a public document depository. Purdue 3, at 59-60.

In 2021, after a multi-phase mediation, an agreement in principle was made among Debtors, the Sacklers, and various public and private claimants. The agreement provided that, in return for releases from Debtors and their creditors, the Sacklers would contribute at least $4.275 billion to Debtors’ estate over nine years. A group of 25 non-consenting States (including the District of Columbia (“DC”)), rejected the agreement. The non-consenting States included California, Connecticut, Delaware, Maryland, Oregon, Rhode Island, Vermont, Washington, and DC (the “Nine”). On March 15, 2021, Debtors filed their proposed plan and disclosure statement, which included a term sheet for a settlement with the Sacklers. Purdue 3, at 60-61; Purdue 2, at 64-65.

During May-June, 2021, in a third phase of the mediation, the Sacklers and Debtors arrived at a modified agreement with 10 of the 25 non-consenting States, but not the Nine. The Sacklers agreed to increase their aggregate settlement payment to $4.325 billion, and the scope of the proposed public document depository was expanded. Purdue 3, at 60-61; Purdue 2, at 65.

On June 3, 2021, the Bankruptcy Court approved Debtors’ amended disclosure statement and authorized Purdue to solicit votes on Debtors’ fifth amended plan. As subsequently amended, Debtors’ proposed plan (i.e., the “Plan”) provided for: (1) the contribution of Debtors’ assets to a public benefit entity; (2) settlement payments of approximately $4.35 billion to be made by or on behalf the Sacklers over nine years to various trusts set up for distributions to Debtors’ creditors; (3) the establishment of a public document depository; (4) consensual releases of the Sacklers by Debtors’ bankruptcy estates; and (5) releases that permanently enjoined all consenting and non-consenting creditors’ direct and derivative OxyContin-related claims against the Sacklers. Purdue 3, at 60-61, 69-70; Purdue 2, at 66-68. The executive summary in the disclosure statement estimated that $5 billion would be provided to trusts having a mission to abate the opioid crisis and an additional $700 to $750 million would be provided to a trust to make distributions to personal injury claimants, who were estimated to receive distributions of between $3,500 and $48,000 per claimant.

Of Debtors’ over 614,000 creditors, more than 120,000 voted. Each class voted overwhelmingly in favor of the Plan. In August 2021, the Bankruptcy Court conducted a six-day confirmation hearing, which included live testimony of 41 witnesses and extensive oral argument. On September 1, 2021, the Bankruptcy Court orally ruled that it would confirm the Plan, provided that the Plan’s third-party releases were narrowed to specify that, for any released claim, Debtors’ conduct had to be a legal cause or legally relevant factor. Purdue 3, at 61. 

On September 17, 2021, the Bankruptcy Court entered the confirmation order and issued an extensive opinion in Purdue 1. The Bankruptcy Court concluded that it had constitutional and statutory authority to confirm the Plan, including the Plan’s nonconsensual third-party releases. The Plan was the only “reasonably conceivable” way to resolve the issues in Debtors’ cases. Without confirmation of the Plan, Purdue would be forced into liquidation; the DOJ would recover its $2 billion claim; the distribution to creditors would be extremely limited because it would not be supplemented by settlement payments from the Sacklers; and it was likely that they could shield much of their estimated $11 billion fortune from creditors through spendthrift trusts and offshore accounts. Purdue 3, at 62-63 (citing Purdue 1, at 59, 84, 109).   

The UST, the Nine, and others appealed to the United States District Court for the Southern District of New York (the “District Court”). On December 16, 2021, in Purdue 2, Judge McMahon vacated the confirmation order. In Purdue 2, Judge McMahon decided: (1) the Bankruptcy Court had “related to” subject matter jurisdiction of the creditors’ direct claims against third parties; (2) the Bankruptcy Court did not have constitutional authority to enter findings (as opposed to proposed findings) and a final order granting the nonconsensual third-party releases; and (3) the Bankruptcy Code did not authorize the releases.

The District Court certified its decision in Purdue 2 for interlocutory appeals to the Second Circuit, and it authorized those appeals to proceed on an expedited basis. Appeals were filed by Debtors and others, including the Official Committee of Unsecured Creditors, the Ad Hoc Committee of Governmental and Contingent Litigant Claimants, the Ad Hoc Group of Individual Victims of Purdue L.P., the Multi-State Governmental Entities Group, and the Sacklers. Purdue 3, at 67-68.  

In 2022, during the appeals, the Nine settled with Debtors and the Sacklers. In that settlement, the Sacklers agreed to contribute an additional $1.175 billion to $1.675 billion (resulting in aggregate settlement payments of $5.5 billion to $6.0 billion), and the Nine agreed to withdraw their opposition to the Plan. As a result, the remaining appellees were the UST, various Canadian entities, and several pro se personal injury claimants. Purdue 3, at 67-68. The appeals were argued on April 29, 2022. On May 30, 2023, the Second Circuit decided Purdue 3. 

REASONING

In Purdue 3, the Second Circuit decided: (1) the Bankruptcy Court had subject matter jurisdiction; (2) the Bankruptcy Court lacked constitutional authority to grant a final order approving the nonconsensual third-party releases; (3) the releases were valid; and (4) there was no due process violation. 

[1] The Bankruptcy Court had subject matter jurisdiction. A bankruptcy court’s subject matter jurisdiction extends to all civil actions so long as the action’s outcome might have any conceivable effect on the bankruptcy estate. Creditors’ pursuit of direct claims against the Sacklers would likely impact Debtors’ ability to pursue and recover on Debtors’ claims against the Sacklers. Further, the Purdue-Sackler Indemnity Agreement created a possibility that the Sacklers would seek indemnity from the bankruptcy estate. The Bankruptcy Court acted within its jurisdiction over the bankruptcy estate even if the creditors’ claims were not actually the property of Debtors’ bankruptcy estates. Purdue 3, at 71-75.

[2] The District Court correctly treated the Bankruptcy Court’s findings and confirmation order as proposed findings of fact and conclusions of law. Under Stern v. Marshall, 564 U.S. 462 (2011) (Stern), the Bankruptcy Court lacked constitutional authority to make a final order granting the Plan’s nonconsensual third-party releases. The creditors’ direct claims against the Sacklers did not arise from the bankruptcy itself. Those direct claims were made under state law against non-debtors by creditors who did not seek to recover on those claims in Debtors’ cases and had not otherwise consented to the Bankruptcy Court’s adjudication of the claims. The Bankruptcy Court’s permanent injunction of those claims had res judicata effect and “effectively finally resolved” those claims. Under Stern, the District Court in Purdue 2 “correctly construed the bankruptcy court’s decision [in Purdue 1] as setting forth its proposed findings of fact and conclusions of law for the district court’s de novo review.” The “import” of the Stern issue was, however, “nonexistent” given that only conclusions of law were at issue on appeal. Purdue 3, at 68-69.

[3] The Plan’s nonconsensual releases of creditors’ derivative claims were valid. “[I]t is well-settled that a bankruptcy may approve not only third-party releases which are consensual, but also third-party releases of derivative claims because those claims really belong to the [bankruptcy] estate of the debtor.” Purdue 3, at 70. Fraudulent transfer claims, for example, are “typically” derivative claims. Ibid.

[4] In addition, the Plan’s nonconsensual releases of creditors’ direct claims against third parties were valid. The Second Circuit stated: “We now clarify any ambiguity and identify the factors that should be considered in order for a bankruptcy court to approve of nonconsensual third-party releases of direct claims against a non-debtor and to include them in a plan.” Purdue 3, at 77.

In order to confirm a plan granting nonconsensual releases of creditors’ direct claims against third parties, a bankruptcy court must (i) consider each of seven factors (the “Seven Factors”) and (ii) support each of the Seven Factors with “specific and detailed” findings. In addition, (iii) the bankruptcy court must “ordinarily” permit “extensive discovery into the facts surrounding the claims” to be released. Also, (iv) the bankruptcy court must impose the releases “against a backdrop of equity.” The Second Circuit cautioned: “[T]here 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.” Purdue 3, at 77-79.  

The Seven Factors are: (1) whether there is an identity of interests between the debtors and the released third parties, including any indemnification relations, such that a suit against the non-debtor is in essence a suit against the debtor that will deplete the assets of the estate; (2) whether claims against the debtor and non-debtor are factually and legally intertwined, including whether the parties share common defenses, insurance coverage, or levels of the culpability; (3) whether the scope of the release is appropriate in its breadth; (4) whether the releases are essential to the reorganization, in that the debtor needs the claims to be settled in order for the res to be allocated, rather than because the released party is somehow manipulating the process to its own advantage; (5) whether the non-debtor contributed substantial assets to the reorganization; (6) whether the impacted class of creditors overwhelmingly voted in support of the plan (and 75% approval is the bare minimum of this requirement); and (7) whether the plan provides for “fair payment”, not necessarily full payment, of the enjoined claims. Purdue 3, at 78-79.  The Second Circuit cautioned: “As our precedents have suggested, and as we make clear today, if the only reason for the inclusion of a release is the non-debtor’s financial contribution to a restructuring plan, then the release is not essential to the bankruptcy.” Purdue 3, at 81.  

According to the majority opinion in Purdue 3, the “ultimate authority for the imposition of nonconsensual releases of direct third-party claims against non-debtors is rooted – as it must be – in the Bankruptcy Code, specifically 11 U.S.C. §§ 105(a) and 1123(b)(6).” Id., at 72. Section 105(a) states that “[t]he court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of the” Bankruptcy Code. Section 1123(b)(6) states that “a plan may . . . include any other appropriate provision not inconsistent with the provisions of this title.” The Second Circuit agreed with the majority of circuits “that § 105(a) cannot justify the imposition of third-party releases.” Purdue 3, at 73. At least one other provision of the Code must provide the requisite statutory authority. Citing with approval Sixth and Seventh Circuit precedent, the Second Circuit stated: “Although our case law has never expressly cited § 1123(b)(6) to support the imposition of third-party releases, we now explicitly agree with these Circuits and conclude that § 1123(b)(6), with § 105(a), permit bankruptcy courts’ imposition of third-party releases.” Id., at 74. Section 1123(b)(6) “is limited only by what the Code expressly forbids, not what the Code explicitly allows.” Purdue 3, at 73-74 (citing United States v. Energy Resources Co., 495 U.S. 545 (1990) (Energy Resources)).

The Second Circuit declined to follow precedent from the Fifth, Ninth, and Tenth Circuits, including Resorts Int’l Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1401-02 (9th Cir. 1995) (Lowenschuss)). “Our sister circuits that have held that the Bankruptcy Code does not support the imposition of nonconsensual third-party releases rely upon the provisions limiting the discharge of debt under 11 U.S.C. § 524(e).” Purdue 3, at 74. Section 524(e) states that “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.” The Plan’s releases did not grant the Sacklers a discharge because the releases neither offered umbrella protection against liability nor extinguished all claims. Section 524(e) does not expressly prohibit nonconsensual third-party releases. Section 524(e) says “does,” not “shall” or “will” and refers to “such debt.” Where Congress has limited the powers of the bankruptcy court, it has done so clearly. Purdue 3, at 71, 74-75.

The Second Circuit rejected the UST’s argument that 11 U.S.C. § 524(g) showed that §1123(b)(6) should be read narrowly. Section 524(g) authorizes injunctions against third-party claims in asbestos cases. Congress enacted § 524(g) as part of the Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, 108 Stat. 4106 (1994). Section 111(b) of that law included a provision entitled “RULE OF CONSTRUCTION.” See Pub. L. No. 103-394, § 111(b), 108 Stat. 4106, 4117 (1994) (capitals in original) Section 111(b) provides: “Nothing in [§ 524(g)], shall be construed to modify, impair, or supersede any other authority the court has to issue injunctions in connection an order confirming a plan of reorganization.” Purdue 3, at 76 (quoting § 111(b)). “More importantly,” the Second Circuit explained, “this Court’s opinion in Metromedia flatly rejects a restrictive interpretation of the Bankruptcy Code by stating that third-party releases can be valid outside of the asbestos context.” Purdue 3, at 76 (citing In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141 (2d Cir. 2005)). 

[5] The Bankruptcy Court did not violate due process. Creditors received adequate notice and a meaningful opportunity to be heard. The Plan’s releases were sufficiently clear; extensive notice was given; and the Bankruptcy Court conducted a six-day confirmation hearing. Creditors’ inability to opt out of the releases did not violate due process. The Due Process Clause does not absolutely protect against the deprivation of property. Instead, it “ensures that a deprivation does not occur without due process.” Purdue 3, at 83.

AUTHOR’S COMMENTS

[A] The majority opinion in Purdue 3 is problematic for several reasons. First, Purdue 3 states that “§ 1123(b)(6) is limited only by what the Code expressly forbids, not what the Code explicitly allows.” Id., at 73-74 (emphasis added). Section 1123(b)(6) is not limited “only” by what the Bankruptcy Code expressly forbids. Instead, § 1123(b)(6) expressly requires that a chapter 11 plan must be both “appropriate” and “not inconsistent” with the Code. Section 1123(b)(6) does not state that it is appropriate for a plan to release claims that do not belong to the debtor or the bankruptcy estate. In addition, § 1123(b)(6) does not state that it is appropriate for a plan to include provisions that circumvent § 524(e).   

Second, in Energy Resources, the Supreme Court did not hold or state that the Bankruptcy Code authorizes nonconsensual third-party releases. In Energy Resources, the third parties’ indebtedness to the IRS was reduced only to the extent that it was actually paid. The third parties did not get released except to the extent that the debtor paid the trust fund taxes for which the third parties were liable to the IRS as responsible parties under 26 U.S.C. § 6672. See IRS v. Energy Resources Co. (In re Energy Sources Co.); 871 F.2d 223, 233 (1st Cir. 1989) (“And, so long as there is a ‘trust fund’ tax debt outstanding, nothing, including our opinion today, legally restrains the IRS attempting to collect ‘trust fund’ taxes from responsible individuals.”), affirmed sub. nom., United States v. Energy Res. Co., 495 U.S. 545, 550-51 (1990); see Transcript of Oral Argument at 46 (debtors’ counsel argued: “I am not asking that they [i.e., the officers] be taken off the hook. The Section 6672 liability remains.”), United States v. Energy Resources, Co., No. 89-255 (argued March 19, 1990), available at https:////www.supremecourt.gov/pdfs/transcripts/1989/89-255_03-19-1990.pdf.

Third, the majority opinion in Purdue 3 relies on circuit court precedent that is doubtful in light of subsequent Supreme Court precedent. Quoting Airadigm Commc’ns, Inc. v. FCC (In re Airadigm Commc’ns, Inc.), 519 F.3d 640 (7th Cir. 2008) (Airadigm), the majority opinion in Purdue 3 states, “where Congress has limited the powers of the bankruptcy court, it has done so clearly[.]” Id., at 74-75. In Czyzewkski v. Jevic Holding Corp., 580 U.S. 451 (2017) (Jevic), the Court decided that the general authorizations in 11 U.S.C. §§ 349 and 1112 were impliedly limited by the Code’s priority scheme. The Court stated: “Congress . . . does not, one might say, hide elephants in mouseholes[.]” Jevic, at 465 (quoting Whitman v. American Trucking Assns., Inc., 531 U.S. 457, 468 (2001)). Citing Jevic, Judge Wesley stated in his concurring opinion: “At bottom, if Congress intended so extraordinary a grant of authority, it should say so.” Purdue 3, at 90.   

Fourth, under state law, victims of joint tortfeasors have a statutory right to release and settle with one tortfeasor without discharging non-settling joint tortfeasors. See, e.g., Cal. Code Civ. Proc. § 877(a) (a release given in good faith to a joint tortfeasor “shall not discharge” the other joint tortfeasors, “but it shall reduce the claims against the others in the amount stipulated by the release” or “in the amount of consideration paid for it, whichever is greater.”). Section 1123(a) of the Code states what a plan must provide “[n]otwithstanding any otherwise applicable non-bankruptcy law[.]” By its terms, § 1123(a) does not override bankruptcy laws, including § 524(e), and courts are divided on the extent to which § 1123(a) preempts state law. Compare PG&E Co. v. Cal. Ex rel. Cal. Dept. of Toxic Substances Control, 350 F.3d 932, 948 (9th Cir. 2003) (like § 1142(a), § 1123(a) preempts only otherwise applicable nonbankruptcy laws relating to financial condition) with In re Federal Mogul Global, 684 F.3d 355, 374 (3rd Cir. 2012) (preemptive scope of § 1123(a) is not “limitless” but is not limited “to the preemptive reach of § 1142(a)”); see also Irving Tanning Co. v. Me. Superintendent of Ins., 496 B.R. 644, 664 (B.A.P. 1st Cir. 2013) (“Third, for both statutory and constitutional reasons, the preemptive effect of § 1123(a) cannot extend to laws defining and protecting the property rights of third parties.”).      

Fifth, Purdue 3 upheld nonconsensual third-party releases that did not except claims that would be nondischargeable by the Sacklers if they filed bankruptcy. It is doubtful that such releases are “appropriate to carry out” the Code as required by § 105(a) or are “appropriate” and “not inconsistent” with the Code as required by § 1123(b)(6). 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 § 1141(d) of the Code to restrict corporate debtors from discharging their liability to domestic governmental units for fraud of the type specified in §§ 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.), 634 B.R. 22, 31-37 (S.D.N.Y. 2021) (penalty owed to FCC and traceable to corporate debtor’s fraud was excepted by § 1141(d)(6) from discharge in chapter 11).

[B] Practitioners in the Ninth Circuit should keep in mind the third-party release rules that currently apply in this circuit. First, the Ninth Circuit does not prohibit all nonconsensual third-party releases in bankruptcy cases. After Lowenschuss, in Blixseth v. Credit Suisse, 961 F.3d 1074 (9th Cir. 2020), the Ninth Circuit clarified that § 524(e) does not prohibit a bankruptcy court from approving a chapter 11 plan’s exculpation clause, provided it does not release the exculpated party from (1) pre-petition claims and (2) post-petition claims for willful misconduct or gross negligence. Citing Blixseth, in In re Astria Health, 623 B.R. 793 (Bankr. E.D. Wash. 2021) (Astria Health), United States Bankruptcy Judge Whitman Holt characterized as “misguided conventional wisdom” the view that the Ninth Circuit “categorically prohibits nondebtor releases.” Id., 623 B.R. at 802.

Second, the Ninth Circuit’s prohibition of nonconsensual third-party releases does not apply to causes of action that are nominally asserted by third parties but in fact belong to the bankruptcy estate. Avoidance and derivative claims nominally asserted by third parties belong to the debtor’s bankruptcy estate and therefore are controlled by it. See Koeberer v. Cal. Bank of Commerce (In re Koeberer), 632 B.R. 680, 689 (9th Cir. 2021); In re Mark One Corp., 619 B.R. 423, 439 (Bankr. E.D. Cal. 2020); In re Pac. Gas & Elec. Co., 304 B.R. 395, 418 n.26 (Bankr. N.D. Cal. 2004); but see In re Fraser’s Boiler Serv., 2019 U.S. Dist. LEXIS 37840, *16-17 (W.D. Wash. 2019).

Third, the Ninth Circuit’s prohibition of third-party releases in bankruptcy cases is not a defense to the binding effect of a confirmed chapter 11 plan that contains third-party releases. Once final, a plan confirmation order is res judicata and binds parties who received adequate notice, even if the order was erroneous. Travelers Indem. Co. v. Bailey. 557 U.S. 137, 152, 155 (2009); Iberiabank v. Geisen (In re FFS Data, Inc.), 776 1299, 1306-09 (11th Cir. 2015) (third-party release of debtor’s guarantor in chapter 11 plan had res judicata effect); see also United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260, 269-70 (2010) (order confirming chapter 13 plan that unlawfully discharged student loan was not void); Jackson v. Le Ctr. on Fourth, LLC (In re Le Ctr. on Fourth, LLC), 17 F.4th 1326 (11th Cir. 2021) (applying Espinosa in chapter 11 case).

Fourth, the Ninth Circuit’s prohibition of nonconsensual third-party releases does not prevent such releases when they are authorized by applicable non-bankruptcy laws. In 1995, one year after Congress enacted the asbestos-related provisions of 11 U.S.C. §§ 524(g) and (h) (and an uncodified rule of construction in § 111 of the 1994 legislation), Congress enacted 15 U.S.C. § 78u-4 as part of the Private Securities Litigation Reform Act of 1995. Section 78u-4 authorizes nonconsensual releases of claims for indemnity and contribution in federal securities litigation. That aspect of § 78u-4 resembles Cal. Code Civ. Proc. § 877.6, which authorizes nonconsensual releases of claims for indemnity and contribution under specified circumstances under California law. See Heritage Bond Litig. v. US. Trust Corp., 546 F.3d 667 (9th Cir. 2008).  

Fifth, because the Ninth Circuit’s prohibition on third-party releases is based on 11 U.S.C. § 524(e), the Ninth Circuit’s prohibition does not to apply to chapter 9 municipal cases, chapter 15 cross-border cases, chapter 11 asbestos cases, or other situations where § 524(e) does not apply. See 11 U.S.C. §§ 103(a), 524(g)(4)(A)(ii), 901(a), 1507, and 1520; In re City of San Bernardino, 566 B.R. 46, 57 (Bankr. C.D. Cal. 2017) (chapter 9 case); Ad Hoc Group of Vitro Noteholders v. Vitro SAB De CV (In re Vitro SAB De CV), 701 F.3d 1031, 1602 (5th Cir. 2012) (dicta that nonconsensual third-party release is “theoretically” available relief under § 1507); Lowenschuss, 67 F.3d at 1402 n.6; Motor Vehicle Cas. Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), 677 F.3d 869, 877 (9th Cir. 2011) (asbestos case). 

Sixth, the Ninth Circuit’s prohibition of third-party releases in bankruptcy cases does not prohibit consensual third-party releases. See, e.g., In PG&E Corp., 617 B.R. 671, 683-84 (Bankr. N.D. Cal. 2020) (PG&E) (stating that Lowenschuss “is inapplicable when a non-debtor has consented to the third-party release[.]”). In Astria Health, Judge Holtapproved third-party releases that were “entirely consensual under any framework” and “freely and fairly given.” Id., 623 B.R. at 803. In In PG&E, United States Bankruptcy Judge Dennis Montali approved a third-party release that “require[d] the non-debtor parties to affirmatively opt-in to a release of their claims.” Id., at 683.  

Seventh, in the Ninth Circuit, a creditor’s silence in response to an opt-out notice of a proposed third-party release may not be deemed consent, although the circuit court has not definitively decided that issue. In Astria Health, Judge Holt stated that “courts are split about whether creditors must affirmatively ‘opt in’ to such releases or whether it is sufficient to give creditors a ‘opt out,’” and decided against “wad[ing] into that debate today.” Id., at 803 (footnotes omitted).  

These materials were written by Leonard L. Gumport of Gumport Law Firm, PC (lgumport@gumportlaw.net). Editorial contributions were provided by Summer Shaw of Shaw & Hanover, PC (ss@shaw.law).