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    S.D.N.Y. Judge Issues Disruptive Decision on Third-Party Releases in High-Stakes Purdue Cases

    S&K Analysis
    December 23, 2021

    Last week, U.S. District Court Judge Colleen McMahon of the Southern District of New York sent shockwaves through the bankruptcy bar when she handed down a 142-page decision overturning the confirmation of Purdue Pharma’s chapter 11 plan of reorganization (the “Plan”).1 The decision turned on Judge McMahon’s finding that the Bankruptcy Code does not authorize nonconsensual third-party releases against non-debtor parties—an issue that appellate courts around the nation have disagreed on and one that the Second Circuit has not directly addressed. Although this decision is likely not the final word on the issue, it is likely to have far-reaching ramifications, both in the billion-dollar Purdue cases and other cases nationwide. We summarize the decision and assess its potential impact below.

    Background

    In September 2019, Purdue filed for bankruptcy after securing a deal with 24 states to settle claims that its role in pushing OxyContin, its chief product, spurred the nation’s opioid crisis. Two years later, after much negotiating, mediation, and lengthy court hearings, U.S. Bankruptcy Judge Robert D. Drain approved the Plan, which implemented a revised settlement that enjoyed relatively broad support.2 The Plan established a channeling trust to pay opioid claims and, notably, in exchange for their contribution of over $4 billion, provided broad nonconsensual releases of third-party direct claims against the Sackler family, affiliates, and related entities (the “Third-Party Releases”).

    The Third-Party Releases functionally extinguished all civil claims against the Sacklers, including those already asserted or those that might be asserted in the future, that in any way related to Purdue’s operations.3 In exchange, the Sacklers contributed $4.325 billion to the fund that would be used to resolve public and private civil claims as well as civil and criminal settlements with the federal government. Judge Drain found that this was the “rare” and “unique” case in which a nonconsensual third-party release was appropriate—relying largely on a Second Circuit decision that indicated such releases could be approved in “appropriate, narrow circumstances.”4 Judge Drain compared the power to grant the Third-Party Releases to a bankruptcy court’s widely-recognized power to impose a preliminary injunction against the prosecution of third-party claims to facilitate the reorganization process, which he believed could become permanent if crucial to a reorganization process involving massive numbers of overlapping estate and third-party claims.5 He found the authority to make such a ruling based on multiple sections of the Bankruptcy Code, including section 105(a) (a court may issue any order that is necessary or appropriate to carry out the provisions of the Bankruptcy Code), section 1123(a)(5) (a plan shall provide adequate means for its implementation), section 1123(b)(6) (a plan may include any other appropriate provision not inconsistent with the applicable provisions of the Bankruptcy Code), and section 1129(a) (a court shall confirm a plan only if the plan complies with the applicable provisions of the Bankruptcy Code), together with the bankruptcy court’s inherent equitable power or “residual authority.”6

    Shortly after the Plan was confirmed, a group of state attorneys general, Canadian municipalities, First Nation groups, pro se individuals, and the U.S. Trustee, who previously objected to the Plan, filed an appeal that challenged the Third-Party Releases. They argued, among other things, that there was no statutory authority to grant non-debtor releases of third-party claims without the approval of those claimants.

    Judge McMahon’s Decision

    On December 16, 2021, Judge McMahon ruled that the Third-Party Releases were not permitted under the Bankruptcy Code. Specifically, she found that “[c]ontrary to the bankruptcy judge’s conclusion, Sections 105(a) and 1123(a)(5) & (b)(6), whether read individually or together, do not provide a bankruptcy court with [statutory] 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.”7

    Judge McMahon asserted that sections 524(g) and (h) of the Bankruptcy Code, which expressly allow nonconsensual third-party releases, are plainly limited to the asbestos context and have never been extended beyond that context by Congress.8 She reasoned that to the extent Congress has been silent in the twenty-seven years since enacting section 524(g)—a time when certain courts applied that section to bankruptcy cases involving medical devices9 and securities10—that should not be deemed as Congress’s implicit consent to 524(g)’s expansion.11 She explained, in particular, “[t]he notion that statutory authority can be inferred from Congressional silence is counterintuitive when, as with the Bankruptcy Code, Congress put together a comprehensive scheme designed to target specific problems with specific solutions.”12

    According to Judge McMahon, the general provisions relied on by Judge Drain, although pragmatic, did not “justify expanding the express authority conferred by Congress under §524(g) into a situation that is manifestly not comprehended by that statute.”13 She found that it was well-settled in the Second Circuit that section 105(a), standing alone, “confers on the Bankruptcy Court only the power to enter orders that carry out other, substantive provisions of the Bankruptcy Code.”14 She found however, that neither section 105(a) nor any of the other sections of the Bankruptcy Code relied on by Judge Drain actually conferred any authority to approve the Third-Party Releases: (i) section 1123(b)(6) was insufficient because it is “substantively analogous to Section 105(a)’s authorization”15; (ii) section 1123(a)(5) “does not authorize a court to give its imprimatur to something the Bankruptcy Code does not otherwise authorize, simply because doing so would ensure funding for a plan”16; and (iii) “§1129(a) confers no substantive right that could be used to undergird a § 105(a) injunction.”17 Lastly, Judge McMahon found that “residual authority” under the Bankruptcy Code “simply does not exist.”18 Even if it did, Judge McMahon found that it would not apply here because the Third-Party Releases were inconsistent with applicable provisions of the Bankruptcy Code, including sections 524(g) and (h).19

    Takeaway

    It seems inevitable that the Second Circuit will consider this, and then potentially the U.S. Supreme Court. It is certainly not an easy issue. On one hand, the inability to grant such third-party releases has the potential to harm creditors by making settlements more difficult to achieve in large litigation scenarios. Defendants always seek finality and may be unwilling to resolve litigation when finality is not possible. In Purdue, the Sacklers asserted that they would only contribute to Purdue’s estate if they could put all Oxycontin-related litigation behind them. If Judge McMahon’s decision is ultimately upheld, it could unwind the Plan and leave litigation claimants fighting over Purdue’s corpse. They could pursue their claims against the Sacklers, but the validity of those claims (particularly in light of defenses that may be available) and the collectability of potential judgments is uncertain to say the least. Such a situation could result in the loss of billions of dollars for abatement and victim compensation. Judge McMahon herself acknowledged that “the invalidating of these releases will almost certainly lead to the undoing of a carefully crafted plan that would bring about many wonderful things, including especially the funding of desperately needed programs to counter opioid addiction.”20 For that very reason, major creditor groups—including the official committee of unsecured creditors—were unwilling to gamble on future litigation against the Sacklers.

    On the other hand, as Judge McMahon pointed out, this issue, which has “hovered over bankruptcy law for thirty-five years” needed a “a clear answer.”21 If such authority does not exist in the Bankruptcy Code, then it would be up to Congress to create such authority. To the extent that Judge McMahon’s critique of Congressional silence will spur Congressional action, however, they may have already showed their hand. Earlier this year, Congressional Democrats introduced legislation, in direct response to the Purdue settlement, that would expressly ban nonconsensual third-party releases. Certainty, whichever position it favors, will benefit parties to future cases. Sophisticated market participants and professionals will adjust to the “new normal,” even if it eliminates a tool from the toolbox of the restructuring profession.

    Purdue has already promised to appeal Judge McMahon’s decision and has sought an extension of the preliminary injunction enjoining third-party claims against the Sacklers while they figure out a path forward. Given the magnitude of the underlying issues and the varying Circuit court decisions on the issue, any future Second Circuit decision would be ripe for review by the Supreme Court. If that happens, Judge McMahon’s decision could be the death knell for nonconsensual third-party releases and fundamentally alter the legal landscape of certain chapter 11 cases nationwide.


    1 In re Purdue Pharma L.P., Case No. 7:21-cv-7532 (S.D.N.Y. Dec. 16, 2021) (hereinafter Purdue II).

    2 In re Purdue Pharma L.P., Case No. 19-23649, 2021 Bankr. LEXIS 2555 (Bankr. S.D.N.Y. Sept. 17, 2021) (hereinafter Purdue I).

    3 Judge Drain insisted that the Third-Party Release be modified such that it covered only third-party claims in which “a Debtor’s conduct, or a claim asserted against the Debtor, [was] a legal cause of the released claim, or a legally relevant factor to the third-party cause of action against the shareholder released party.” Id. at *130-31..

    4 Deutsche Bank A.G. v. Metromedia Fiber Network, Inc., (In re Metromedia Fiber Network, Inc.), 416 F. 3d 136, 141 (2d Cir. 2005).

    5 See Purdue I at *121.

    6 See id. at *130.

    7 Purdue II at 73.

    8 Id. at 104.

    9 See In re A.H. Robins Co., Inc., 880 F.2d 694 (4th Cir. 1989).

    10 See In re Drexel Burnham Lambert Grp., Inc., 960 F. 2d 285 (2d Cir. 1992).

    11 Purdue II at 129-30.

    12 Id. at 131 (internal quotation marks and citation omitted).

    13 Id. at 132.

    14 Id. at 120.

    15 Id. at 121.

    16 Id. at 126.

    17 Id. at 126-27.

    18 Id. at 132.

    19 Id. at 134-35.

    20 Id. at 137.

    21 Id. at 6-7.

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