United States: Second Circuit Green Lights Purdue Pharma Chapter 11 Plan Containing Nonconsensual Third-Party Releases

There is longstanding controversy concerning the validity of third-party release provisions in non-asbestos trust chapter 11 plans that limit the potential exposure of various non-debtor parties involved in the process of negotiating, implementing and funding a plan. In the latest chapter of this debate, the U.S. Court of Appeals for the Second Circuit handed down a long-awaited ruling regarding the validity of nonconsensual third-party releases in the chapter 11 plan of pharmaceutical company Purdue Pharma, Inc. and its affiliated debtors (collectively, "Purdue"). In In re Purdue Pharma L.P., 69 F.4th 45 (2d Cir. 2023), the Second Circuit reversed a district court decision finding that the bankruptcy court lacked the power to approve a plan provision releasing the founding Sackler family from liabilities arising from Purdue's sale of opioids and affirmed the bankruptcy court order confirming Purdue's chapter 11 plan.

Chapter 11 Plan Releases

Section 524(e) of the Bankruptcy Code provides that, "[e]xcept as provided in subsection (a)(3) of this section [making the discharge injunction applicable to actions to collect against community property], 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." Even so, chapter 11 plans confirmed by bankruptcy courts in certain circuits commonly include provisions that release various non-debtors from certain debtor liabilities.

Third-party releases can provide for the relinquishment of both prepetition and postpetition claims belonging to the debtor or non-debtor third parties (e.g., creditors) against various non-debtors. As such releases have become common features of chapter 11 plans, they also have become more controversial.

It is generally accepted that a chapter 11 plan can release non-debtors from claims of other non-debtor third parties if the release is consensual. See generally Collier on Bankruptcy ("Collier") ¶ 524.05 (16th ed. 2023) (citing cases). What constitutes consent, however, is sometimes disputed. Collier at ¶ 1141.02[5](b) (discussing various opt-out and opt-in mechanisms that have been attempted as a manifestation of consent for impaired and unimpaired creditors); Lisa M. Schweitzer, Third-Party Releases in Chapter 11 Plans: Key Considerations and Recent Developments, in Nuts and Bolts of Corporate Bankruptcy 2021, at 323 (Practising Law Institute Commercial Law and Practice Course Handbook Series, PLI Order No. A-1043, 2021) (same).

In addition, a plan that establishes a trust under section 524(g) of the Bankruptcy Code to fund payments to asbestos claimants can enjoin litigation against certain third parties (e.g., entities related to the debtor or its insurers) alleged to be liable for the conduct of, claims against, or demands on the debtor. See 11 U.S.C. § 524(g)(4). Section 524(g) was added to the Bankruptcy Code in 1994 in the wake of the historic Johns-Manville and UNARCO Industries chapter 11 cases. It was enacted to provide explicit statutory authority for courts to issue channeling injunctions in respect of asbestos claims and demands, including those held by persons who have been exposed to asbestos but have not yet manifested any signs of illness.

The circuit courts of appeals are split as to whether a bankruptcy court has the authority, other than under section 524(g), to approve chapter 11 plan provisions that, over the objection of creditors or other stakeholders, release specified non-debtors from liability or enjoin dissenting stakeholders from asserting claims against such non-debtors. The minority view, held by the Fifth and Tenth Circuits-and until 2020, arguably the Ninth Circuit (see below)-bans such nonconsensual releases on the basis that they are prohibited by section 524(e) of the Bankruptcy Code. See Bank of N.Y. Trust Co. v. Official Unsecured Creditors' Comm. (In re Pac. Lumber Co.), 584 F.3d 229 (5th Cir. 2009); Resorts Int'l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394 (9th Cir. 1995); In re W. Real Estate Fund, Inc., 922 F.2d 592 (10th Cir. 1990); see also Blixseth v. Credit Suisse, 961 F.3d 1074, 1083-84 (9th Cir. 2020) (suggesting, contrary to Lowenschuss and other previous rulings, that section 524(e) does not preclude certain non-debtor plan releases of claims that are not based on the debt discharged by the plan), cert. denied, 141 S. Ct. 1394 (2021).

On the other hand, the majority of the circuits that have considered the issue have found such releases and injunctions permissible under certain circumstances. See SE Prop. Holdings, LLC v. Seaside Eng'g & Surveying, Inc. (In re Seaside Eng'g & Surveying, Inc.), 780 F.3d 1070 (11th Cir. 2015); In re Airadigm Commc'ns, Inc., 519 F.3d 640 (7th Cir. 2008); In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002); In re Drexel Burnham Lambert Grp., Inc., 960 F.2d 285 (2d Cir. 1992); In re A.H. Robins Co., Inc., 880 F.2d 694 (4th Cir. 1989). For authority, these courts generally rely on section 105(a) of the Bankruptcy Code, which authorizes courts to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]." Moreover, as the Seventh Circuit held in Airadigm, the majority view is that section 524(e) does not limit a bankruptcy court's authority to grant such releases. Airadigm, 519 F.3d at 656 ("If Congress meant to include such a limit, it would have used the mandatory terms 'shall' or 'will' rather than the definitional term 'does.' And it would have omitted the prepositional phrase 'on, or . for, such debt,' ensuring that the 'discharge of a debt of the debtor shall not affect the liability of another entity'-whether related to a debt or not.").

As authority for such involuntary releases, some courts have also relied on section 1123(a)(5) or 1123(b)(6) of the Bankruptcy Code. See, e.g., Airadigm, 519 F.3d at 657; In re Scrub Island Dev. Grp. Ltd., 523 B.R. 862, 875 (Bankr. M.D. Fla. 2015). The former states that a chapter 11 plan "shall . provide adequate means for the plan's implementation," including a non-exclusive list of examples. The latter provides that a chapter 11 plan may "include any other appropriate provision not inconsistent with the applicable provisions of [the Bankruptcy Code]."

The First and D.C. Circuits have suggested that they agree with the "pro-release" majority, depending upon the specific circumstances. See In re Monarch Life Ins. Co., 65 F.3d 973 (1st Cir. 1995) (a debtor's subsidiary was collaterally estopped by a plan confirmation order from belatedly challenging the jurisdiction of the bankruptcy court to permanently enjoin lawsuits against the debtor's attorneys and other non-debtors not contributing to the debtor's reorganization); In re AOV Indus., 792 F.2d 1140 (D.C. Cir. 1986) (a plan provision releasing liabilities of non-debtors was unfair because the plan did not provide additional compensation to a creditor whose claim against the non-debtor was being released; adequate consideration must be provided to a creditor forced to release claims against non-debtors).

In In re Millennium Lab Holdings II, LLC, 945 F.3d 126 (3d Cir. 2019), the Third Circuit refrained from "broadly sanctioning the permissibility of nonconsensual third-party releases in bankruptcy reorganization plans," but, based on the "specific, exceptional facts" of the case, upheld a lower court decision confirming a chapter 11 plan containing nonconsensual third-party releases, finding that the order confirming the plan did not violate Article III of the U.S. Constitution.

Even courts in the majority camp acknowledge that nonconsensual plan releases should be approved only in rare or unusual cases. See Seaside Eng'g, 780 F.3d at 1078; Nat'l Heritage Found., Inc. v. Highbourne Found., 760 F.3d 344, 347-50 (4th Cir. 2014); Behrmann v. Nat'l Heritage Found., 663 F.3d 704, 712 (4th Cir. 2011); In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141-43 (2d Cir. 2005).

Recent lower court rulings also highlight the deep division among courts on this issue. See, e.g., In re Boy Scouts of Am. & Delaware BSA, LLC,650 B.R. 87 (D. Del. 2023) (ruling that the bankruptcy court had "related to" jurisdiction to confirm a chapter 11 plan providing for nonconsensual third-party releases and a channeling injunction, which were permissible under sections 105(a), 1123(a)(5), and 1123(b)(6) and necessary to ensure an equitable process by which abuse survivors' claims would be administered and paid), appeal filed, No. 23-1668 (3d Cir. Apr. 11, 2023); In re Mallinckrodt PLC, 639 B.R. 837 (Bankr. D. Del. 2022) (concluding that bankruptcy courts have statutory and constitutional authority to approve chapter 11 plans containing nonconsensual third-party releases, albeit only in extraordinary cases, and holding that, given the extraordinary nature of the case, nonconsensual opioid releases in the plan of debtor-drug manufacturers were integral to the plan's success and would be approved as fair and reasonable), stay pending appeal denied, 2022 WL 1206489 (D. Del. Apr. 22, 2022); Patterson v. Mahwah Bergen Retail Group, Inc., 636 B.R. 641 (E.D. Va. 2022) (vacating a bankruptcy court order confirming a retail group's chapter 11 plan and ruling that the plan impermissibly authorized nonconsensual third-party releases because the bankruptcy court lacked constitutional authority to adjudicate the released claims and failed to analyze whether the releases were justified under Fourth Circuit precedent).

Majority-view courts employ various tests to determine whether such releases are appropriate. Factors generally considered by courts evaluating third-party plan releases or injunctions include whether they are essential to the reorganization, whether the parties being released have made or are making a substantial financial contribution to the reorganization, and whether affected creditors overwhelmingly support the plan. See Dow Corning, 280 F.3d at 658 (listing factors).

Purdue Pharma

In September 2021, Purdue obtained confirmation of a chapter 11 plan that included nonconsensual releases of various non-debtors, including Purdue's founders the Sackler family, of liabilities associated with Purdue's sale of OxyContin, in exchange for the Sackler family's ownership interest in the companies and more than $4 billion to settle OxyContin litigation claims. At the time of Purdue's bankruptcy filing, Purdue and the Sacklers were defendants in 3,400 lawsuits seeking an estimated $40 trillion in damages, whereas the value of Purdue's assets was estimated at no more than $1.8 billion.

In December 2021, the U.S. District Court for the Southern District of New York vacated the plan confirmation order, ruling that the bankruptcy court did not have authority under the U.S. Constitution or the Bankruptcy Code to approve nonconsensual releases granted under the plan to the Sacklers. According to the district court, the released claims at issue were "non-core" under the U.S. Supreme Court's ruling in Stern v. Marshall, 564 U.S. 462 (2011), and the bankruptcy court could not constitutionally enter a final order that effectively finally adjudicated the released claims but, rather, should have issued proposed findings of fact and conclusions of law regarding such claims (and the releases thereof) to the district court. In addition, the district court wrote:

Contrary to the bankruptcy judge's conclusion, Sections 105(a) and 1123(a)(5) & (b)(6) [of the Bankruptcy Code], whether read individually or together, do not provide a bankruptcy court with such authority; and there is no such thing as 'equitable authority' or 'residual authority' in a bankruptcy court untethered to some specific, substantive grant of authority in the Bankruptcy Code.

In re Purdue Pharma, L.P., 635 B.R. 26, 78 (S.D.N.Y. 2021), rev'd and remanded, 69 F.4th 45 (2d Cir. 2023).

On January 27, 2022, the Second Circuit granted the request of Purdue, various creditor and claimant groups, and several Sackler family members for leave to appeal the district court's interlocutory order vacating the bankruptcy court's confirmation order.

In February 2022, the Sacklers agreed to add more than $1.6 billion to the $4.3 billion settlement that they would have paid under Purdue's original chapter 11 plan. Pending the Second Circuit's hearing and deliberations on the dispute, a court-appointed mediator explored a possible global settlement between Purdue and parties opposing the plan. As a result of these negotiations, many parties agreed to the terms of a revised plan, reflecting, among other things, the Sackler family's increased financial contribution. By the time the Second Circuit handed down its ruling on the appeal, the remaining appellees consisted of the U.S. Trustee, several Canadian municipalities and indigenous nations, and several individual pro se plaintiffs.

The Second Circuit's Ruling

Sixteen months after it agreed to hear Purdue's appeal, a three-judge panel of the Second Circuit reversed the district court's order holding that the Bankruptcy Code does not permit nonconsensual releases of third-party direct claims against non-debtors, affirmed the bankruptcy court's confirmation of Purdue's chapter 11 plan, and remanded the case below for further proceedings.

Writing for the panel, U.S. Circuit Court Judge Eunice C. Lee explained at the inception of the court's opinion that, "[w]hen a bankruptcy is the result of mass tort litigation against the debtor, the complexities [inherent in a process where no one is completely satisfied] are magnified because the debts owed are wide-ranging and the harm caused goes beyond the financial." Purdue Pharma, 69 F.4th at 56. Judge Lee acknowledged the important policy implications, including considerations of fairness, raised by the approval of a chapter 11 plan that includes nonconsensual non-debtor releases of parties from liability "for actions that cause great societal harm." Id. at 57. Even so, she wrote, "our role in this appeal does not require us to answer all of these serious and difficult questions." Instead, she explained, "we are tasked only with resolving two key questions: First, does the Bankruptcy Code permit non-consensual third-party releases of direct claims against non-debtors, and, Second, if so, were such releases proper here in light of all equitable considerations and the facts of this case." Id.

Addressing the first question, the Second Circuit panel concluded that the bankruptcy court had both jurisdiction and statutory authority to approve the third-party releases in Purdue's chapter 11 plan.

Initially, Judge Lee explained, a bankruptcy court's "ability to release claims at all derives from its power of discharge" under section 524(a), which provides that a bankruptcy discharge, among other things, releases a debtor from personal liability for any debt by enjoining creditors from attempting to collect on it. Although section 524(e) of the Bankruptcy Code provides that a debtor's discharge "does not affect the liability of any other entity on . such debt," Judge Lee emphasized that the releases in Purdue's chapter 11 plan "do not constitute a discharge of debt for the Sacklers because the releases neither offer umbrella protection against liability nor extinguish all claims." Id. at 70.

The Second Circuit panel agreed with the lower courts that the bankruptcy court had statutory jurisdiction to approve the releases "because it is conceivable, indeed likely, that the resolution of the released claims would directly impact" Purdue's bankruptcy estate even though many of the claims were asserted directly against the Sackler officers and directors, who were indemnified by Purdue for liabilities that did not arise from bad-faith conduct. Id. at 71.

The Second Circuit panel also concluded that nonconsensual third-party releases may be approved as part of a chapter 11 plan under sections 105(a) and 1123(b)(6) of the Bankruptcy Code. Although section 105(a) alone cannot provide authority to approve such releases, Judge Lee explained, section 1123(b)(6) fills the gap consistent with the Supreme Court's conclusion in United States v. Energy Resources Co., 495 U.S. 545 (1990), that section 1123(b)(6)- "acting in tandem with § 105(a)-grants bankruptcy courts a 'residual authority' consistent with 'the traditional understanding that bankruptcy courts, as courts of equity, have broad authority to modify creditor-debtor relationships.'" Id. at 73 (quoting Energy Resources, 495 U.S. at 549). The Second Circuit panel found the Seventh Circuit's reasoning in Airadigm and the Sixth Circuit's rationale in Dow Corning to be convincing on this point.

The Second Circuit panel distanced itself from courts that have ruled that section 524(e) precludes such releases, emphasizing, as the Seventh Circuit explained in Airadigm, that the language of section 524(e) is not mandatory and does not expressly manifest lawmakers' intent to limit the bankruptcy court's power to release non-debtors. The panel also found ample Second Circuit precedent "support[ing] the approval of a plan containing nonconsensual third-party releases" in non-asbestos liability cases, provided the bankruptcy court makes adequate factual findings and satisfies certain equitable considerations. Id. at 75-77 (citing In re Metromedia Fiber Network, Inc., 416 F.3d 136 (2d Cir. 2005); Drexel, 960 F.2d at 293; MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89, 91 (2d Cir. 1988)).

The Second Circuit panel stated seven factors that a bankruptcy court should consider in deciding whether to approve nonconsensual third-party releases as part of a chapter 11 plan:

(1) "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.'"

(2) "whether claims against the debtor and non-debtor are factually and legally intertwined, including whether the debtors and the released parties share common defenses, insurance coverage, or levels of culpability."

(3) "whether the scope of the releases is appropriate."

(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 with the releases."

(7) "whether the plan provides for the fair payment of enjoined claims."

Id. at 78-79 (citations omitted). In applying these factors, Judge Lee cautioned, "[g]iven the potential for abuse, courts should exercise particular care when evaluating these types of releases." Id. at 79.

The Second Circuit panel found no error in the bankruptcy court's conclusion that the releases in Purdue's chapter 11 plan satisfied all of these factors (other than factor two, which the bankruptcy court did not list but considered in substance in discussing that releases limited to claims legally intertwined with Purdue's conduct were appropriately subject to settlement). Id. at 79-82.

The Second Circuit panel rejected the U.S. Trustee's argument that claimants impacted by the releases were denied procedural due process because the bankruptcy court failed to provide adequate notice of the plan confirmation hearing and the language of the releases was "dense." Judge Lee explained that the bankruptcy court made detailed findings that notice of the confirmation hearing was adequate and that the release language in the plan was "simple . plain English." Id. at 83.

The Second Circuit panel also rejected the U.S. Trustee's argument that a release, without any ability to opt out, cannot comply with due process "because it effectively denies claimants their day in court." According to Judge Lee, this argument ignores the due process findings by the bankruptcy court and "would essentially call into question all releases through bankruptcy, including bankruptcy discharges (which are one of the most important features of bankruptcy)," and the court accordingly "decline[d] to so undermine such a critical component of bankruptcy." Id. at 83.

In a concurring opinion, Circuit Judge Richard C. Wesley stated that the binding precedent in Drexel compelled the conclusion that a bankruptcy court has the power to approve nonconsensual third-party releases as part of a chapter 11 plan, but that "neither Drexel, nor our subsequent discussion of nonconsensual nondebtor releases in Metromedia, traces that power back to any provision of the Bankruptcy Code." Id. at 85. He also urged the U.S. Supreme Court to grant certiorari in any appeal of the ruling, given the lack of uniformity on this issue among the circuits.

Outlook

Third-party releases in non-asbestos chapter 11 plans have long been controversial. Because such releases are commonly the linchpin of heavily negotiated chapter 11 plans involving tens of thousands of creditors, the Second Circuit's ruling in Purdue Pharma is a positive development for companies that file for chapter 11 protection in an effort to manage mass tort and other liabilities. The decision does not represent a sea change in the Second Circuit, which doubled down on its previous rulings that a bankruptcy court can approve such releases under appropriate circumstances. However, Purdue Pharma is notable because the Second Circuit unequivocally ruled that a bankruptcy court has both jurisdiction and statutory authority to approve such releases.

Purdue Pharma and other recent court rulings suggest that the controversy is far from being resolved. As the concurring opinion in Purdue Pharma portends, a certiorari petition seeking review of the Second Circuit ruling by the U.S. Supreme Court will almost certainly be sought (and potentially granted). On July 24, 2023, the Second Circuit denied a motion filed by the U.S. Trustee to stay the mandate of the Second Circuit's ruling pending the Supreme Court's consideration of a certiorari petition, which the U.S. Trustee intends to submit before the August 28, 2023, deadline. The U.S. Trustee argued that staying the decision could prevent equitable mootness arguments if Purdue quickly implements its chapter 11 plan. It also claimed that, if the ruling stands, it could set a precedent for abuse of the bankruptcy system to avoid mass tort liability.

There is also a chance that Congress addresses the issue, since various pieces of legislation have been introduced in recent years regarding third-party releases. For now, the Purdue Pharma decision brings needed clarity in the Second Circuit on the continued viability of the careful use of third-party releases to achieve a confirmable plan in complex chapter 11 cases.

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