On September 1, 2021, a bankruptcy court in New York confirmed a Chapter 11 reorganization plan of Purdue Pharma L.P., one of the country’s largest opioid manufacturers.[1] The plan was significant in that it resolved Purdue’s liabilities linked to the opioid epidemic in exchange for, inter alia, $10 billion in funding to address the opioid crisis. But that was not all. In exchange for a contribution to the estate, Purdue’s plan also provided members of the Sackler family, Purdue’s shareholders, with sweeping immunity from billions of dollars of potential civil claims by third-parties, even though not one family member personally declared bankruptcy.[2]
Purdue’s re-organization prompted significant outcry, with several lawmakers calling to amend the Bankruptcy Code to prohibit non-debtors from receiving releases through the Chapter 11 process.[3] While the merits of those proposals are a matter for public debate, the Purdue case serves as a timely example of the value that third-party releases can provide to stakeholders of debtors moving through the Chapter 11 process, potentially to the detriment of other creditors. Yet, the law regarding the viability of third-party releases is complex and conflicting. Accordingly, in this article we provide a summary of the conflicting law of third-party releases, and practical guidance for corporate counsel to consider when confronted with restructurings that may contemplate such releases.
Conflicting Law
At its most fundamental level, a Chapter 11 bankruptcy plan allows an overburdened debtor to discharge liabilities as part of a judicially approved plan of reorganization. To achieve such an outcome, however, debtors must navigate a myriad of complex and sometimes byzantine rules, while creditors battle over a limited set of assets belonging to the debtor. These are not the only stakeholders in a corporate restructuring, and an increasingly common feature of modern restructuring plans is the provision of third-party releases to non-debtors, sometimes over the dissenting votes of other creditors. As the Sackler’s case demonstrates, non-debtors can reap significant value by obtaining a third-party release.
Federal law is conflicting regarding the legitimacy of a Chapter 11 bankruptcy plan that provides a non-consensual third-party release. Under 11 U.S.C. § 105(a), a bankruptcy court has broad equitable powers to issue “any order, process or judgment that is necessary or appropriate to carry out the provisions of this title.” Citing these broad powers, a majority of the United States Courts of Appeals have held that under certain circumstances, a third-party release may be granted as part of a Chapter 11 plan of reorganization, even over the dissenting votes of creditors who may be negatively impacted by such a release.[4] However, each of these Court of Appeals has indicated that varying standards may apply when determining the propriety of such a release. For instance, the Second Circuit held that while it had identified four circumstances in which a non-consensual third-party release may be appropriate, the issue was “not a matter of factors and prongs.”[5] In contrast, the Sixth Circuit appears to have set forth a seven-factor test focused on, inter alia, the relationship between the third-party and the debtor, the third-party’s contribution to the reorganization, whether the impacted classes voted in favor of the plan, and whether the bankruptcy court made a record of specific factual findings with respect to the relevant factors.[6]
All the meanwhile, the federal courts of Appeals for both the Fifth and Tenth Circuits have held that a third-party release is impermissible because Section 524(e) of the Bankruptcy Code provides that the “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.”[7] And the Third Circuit has, to date, declined to affirm the propriety of a non-consensual third-party release, while also not ruling out that in some circumstances, such a release may be permissible.[8]
Strategies for Assessing Third-Party Releases
With the law so unsettled, this article sets forth four key criteria for any corporate counsel to consider when facing a restructuring situation that may implicate a non-consensual third-party release.
- Forum, Forum, Forum:
A critical factor for determining whether a non-consensual third-party release is permissible is the jurisdiction in which the bankruptcy proceeding takes place. Unsurprisingly, academic research indicates that corporate debtors frequently forum shop when deciding where they will file a bankruptcy petition, and the availability of non-consensual third-party releases certainly influences those decisions.[9] While federal bankruptcy law contains liberal venue provisions (enabling a debtor to file in the state of its domicile, residence, principal place of business, or where a pending bankruptcy of a debtor’s affiliate is), a debtor’s choice of venue is subject to challenge. And, where a creditor can establish that a debtor has likely manipulated its choice of venue to achieve a tactical aim (such as obtaining a third-party release), a motion to transfer venue to a more-favorable jurisdiction with more substantive ties to the bankruptcy proceeding may be an option to protect a creditor’s rights against the third-party.[10]
- The Value Provided by the Released Party:
While the standards applicable in each circuit that permits non-consensual third-party releases varies, each circuit generally requires that the third-party both: (i) contribute substantial assets to the reorganization, and (ii) that the release be essential to the proposed reorganization. As an example, in Purdue Pharma, the court approved the requested third-party releases because: (i) the Sackler’s agreed to contribute roughly $4.3 billion to the proposed plan; and (ii) members of the Sackler family testified that they would not make those contributions absent the third-party releases.[11] However, other Chapter 11 plans that provided for third-party releases have been rejected where the record failed to establish both the third-party’s contribution to the plan, and/or the necessity of the release to the viability of the plan.[12] Accordingly, whenever a bankruptcy plan contemplates the provision of a third-party release, scrutiny must be had of the contribution to the plan of reorganization that will result.
The Terms of Potential Consent:
Corporate counsel must also be wary of traps by which their client may unwittingly consent to a third-party release in a confirmation plan.
Courts have generally concluded that to the extent a creditor consents to a third-party release in a confirmed plan of re-organization, the creditor will be bound by such a release as a matter of contract law.[13] However, the courts are split on what actions, or inactions, will rise to the level of consent with respect to a third-party release. Some bankruptcy courts have held that a creditor that abstains from voting on a plan, despite having adequate notice of a third-party release, will be deemed to have consented to the release.[14] Others, meanwhile, have required the express, affirmative consent to the propriety of such a release.[15] Accordingly, careful review of any ballot provided by the debtor, as well as the implications of voting for or against a plan (or, potentially, abstaining), is necessary to ensure that a creditor avoids unintentionally releasing potentially viable claims against third parties should the plan ultimately be confirmed.
- Challenging the Propriety of a Disclosure:
Finally, affected creditors may be able to challenge the propriety of a plan’s proposed third-party release for failing to comply with mandatory disclosure obligations. Indeed, most federal courts have determined that any proposed Chapter 11 plan of reorganization must, conspicuously and with specificity, identify the third-party releases that are intended to be released.[16] Accordingly, careful review of any Chapter 11 disclosure statement relating to a proposed plan of reorganization could reveal additional bases for objecting to a third-party release.
Conclusion
Third-party releases are a novel, complicated, and evolving, concept of modern bankruptcy jurisprudence which can, potentially, significantly impact creditors’ rights outside of a bankruptcy proceeding. However, with several avenues available to challenge the propriety of such a release, the careful consideration of all relevant factors can protect against the unintentional or unnecessary waiver of a client’s rights.
[1] See, e.g., Meryl Kornfield, Bankruptcy judge approves Purdue Pharma plan to resolve opioid claims, giving Sackler family civil immunity, The Washington Post (Sept. 1., 2021), available at https://www.washingtonpost.com...; The United States Trustee and the attorneys general of several states have filed notices of appeals of the confirmation order. See, e.g., United States Trustee’s Notice of Appeal of Confirmation Order and Order Approving Disclosure Statement, In re Purdue Pharma L.P., Case No. 19-23649 (Bankr. S.D.N.Y.), ECF No. 3776.
[2] See, e.g., Twelfth Amended Joint Chapter 11 Plan of Reorganization of Purdue Pharma L.P. and its Affiliated Debtors, In re: Purdue Pharma L.P., Case No. 19-23649 (Bankr. S.D.N.Y.), ECF No. 3726, § 10.6(b).
[3] Kornfield, supra n.1 (quoting Representatives Carolyn B. Maloney and Mark DeSaulnier’s statements that “[w]e cannot permit powerful people to evade accountability through legal releases in bankruptcy court.”).
[4] See Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136 (2d Cir. 2005); Menard-Sanford v. Mabey (In re A.H. Robins Co., Inc.), 880 F.2d 694, 702 (4th Cir. 1989); Class Five Nevada Claimants v. Down Corning Corp. (In re Dow Corning Corp.), 280 F.3d 648, 658 (6th Cir. 2002); In re Airadigm Commc’ns, Inc., 519 F.3d 640, 657 (7th Cir. 2008); Blixseth v. Credit Suisse, 961 F.3d 1074, 1082 (9th Cir. 2020); In re: Seaside Eng’g & Surveying, Inc., 780 F.3d 1070, 1078 (11th Cir. 2015).
[5] In re Metromedia Fiber Network, Inc., 416 F.3d 136 at 142.
[6] In re Dow Corning Corp., 280 F.3d at 660-661.
[7] 11 U.S.C. § 524(e).
[8] E.g., In re Lower Bucks Hosp., 571 F. App'x 139, 144 (3d Cir. 2014) (“this is not an appropriate case for approval of a non-consensual third-party release”).
[9] See generally Samir D. Parikh, Modern Forum Shopping in Bankruptcy, 46 Conn. Law. Rev. 159 (2013).
[10] See In re Patriot Coal Corp., 482 B.R. 718 (S.D.N.Y. 2012) (transferring case to Eastern District of Missouri in part because of debtors’ purposeful creation of venue-predicate affiliates in New York on the eve of bankruptcy filing).
[11] Kornfield, supra n.1.
[12] E.g., Gilman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 214 (3d Cir. 2000) (vacating order confirming plan with third-party releases that “was not accompanied by any findings that the release was fair to the [non-consenting releasers] and necessary to the . . . reorganization).
[13] See, e.g., In re Specialty Equip. Cos., 3 F.3d 1043, 1047 (7th Cir. 1993) (recognizing that there is no need to unravel the “rather knotty problem” of a release granted by a reorganization to the extent the releases are consensual).
[14] E.g., In re DBSD N. Am., Inc., 419 B.R. 179, 217-19 (Bankr. S.D.N.Y. 2009), aff’d 2010 WL 1223109 (S.D.N.Y. Mar 24, 2010), aff'd in part, rev'd in part on other grounds, 627 F.3d 496 (2d Cir. Dec 6, 2010); In re Indianapolis Downs, LLC, 486 B.R. 286, 306 (Bankr. D. Del. 2013) (finding third-party releases consensual where creditors failed to opt out, either by abstaining from voting or by voting against the plan but not otherwise opting out of the releases).
[15] E.g., In re SunEdison, Inc., 576 B.R. 453, 458-61 (Bankr. S.D.N.Y. 2017); In re Washington Mutual, Inc., 442 B.R. 314, 355 (Bankr. D. Del. 2011).
[16] E.g., Hernandez v. Larry Miller Roofing, Inc., 628 F. App'x 281, 287-88 (5th Cir. 2016).
Published September 28, 2021.
