On Aug. 10, the Supreme Court of the United States entered a short order that may later be seen as one of the final steps toward definitively addressing a bankruptcy issue that has bedeviled both lawyers and courts for decades.
The order granted an application filed by United States Trustee William K. Harrington seeking to stay the approval of the plan of reorganization in the Chapter 11 bankruptcy case of Purdue Pharma. The Supreme Court further stated that it would be treating the application as a writ of certiorari on the issue of 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.” By the order, the Supreme Court also set an expedited schedule for hearing the matter in December.
Absent the entry of this order, the plan of reorganization in the Purdue bankruptcy case would have gone effective pursuant to an opinion issued on May 23 by the U.S. Court of Appeals for the Second Circuit. The issue framed by the Supreme Court deals with what is commonly referred to as “non-consensual third-party releases.” That is, whether bankruptcy courts have the power, via a confirmed plan of reorganization, to release claims against nondebtor parties (that is, people or entities that did not file bankruptcy), even over the objection of the claimant.
The use of non-consensual third-party releases in the Purdue case demonstrates their potential utility. In that case, individuals in the Sackler family — who had not filed bankruptcy — offered approximately $6 billion to fund the Purdue bankruptcy plan in exchange for the release of claims against the Sacklers personally. These members of the Sackler family were the founders of Purdue, and many, many parties took the position that certain of the Sacklers were personally responsible for a large portion of the opioid crisis through the marketing of a prescription drug called OxyContin.
While the claims against Purdue had driven the company into Chapter 11, the Sacklers had not filed individual bankruptcy cases. The fight in the Purdue case came down to the tension between (1) allowing the money to be used — via the confirmed plan — as compensation to millions of victims of the opioid crisis at the cost of letting the Sacklers “get away with it” via broad releases, versus (2) preserving claims against the Sacklers at the cost of having the plan — as it is currently structured — fail, thus leading to uncertain future recoveries for the opioid victims.
While matters concerning the compensation of opioid victims should not be taken lightly, the broader issue of the permissibility of third-party releases has the potential to reverberate far beyond the dispute in the Purdue case. In fact, the Supreme Court’s Aug. 10 order immediately set the bankruptcy commentator community ablaze, with articles quickly appearing in the general press including quotes from academics and bankruptcy lawyers that third-party releases have become ubiquitous in Chapter 11 plans and warnings that bankruptcy as a tool for solving complicated problems will be hampered without this critical element.
However, a review of the history and purpose of non-consensual releases in bankruptcy — which were supposed to be limited to rare and extraordinary cases even according to the courts that allow them — suggests that the prophecies of Chapter 11 doom may be overstated.
The Broad Jurisdiction of Bankruptcy Courts
The circuit spilt over the permissibility of non-consensual third-party releases comes down to a disagreement over whether particular provisions of the Bankruptcy Code allow such releases. In other words, it is a statutory dispute rather than a jurisdictional one. Nevertheless, a general understanding of the broad subject matter jurisdiction helps frame the statutory issues.
Bankruptcy judges are federal judges, but they are not Article III judges. That is, they are not nominated by the president and approved by the Senate under Article III of the Constitution like district court, circuit court and supreme court judges are. Instead, bankruptcy judges are selected through an interview process conducted by the bankruptcy bar and ultimately are chosen through a vote of the circuit court judges for the applicable jurisdiction. While Article III judges have life tenure, bankruptcy judges serve 14-year terms. The bankruptcy system is set up such that bankruptcy judges are “adjuncts” of the district court and bankruptcy cases are administered through an automatic referral from the district court to the bankruptcy court. Thus, from a jurisdictional standpoint, bankruptcy judges are exercising the federal jurisdiction granted by Congress to the district courts.
The non-Article III nature of bankruptcy judges has had significant implications on whether bankruptcy judges have the constitutional authority to enter final orders in certain circumstances, most notably Stern v. Marshall and its progeny. The issue is mentioned here because Stern issues and jurisdictional issues are sometimes blurred together, even by courts and commentators. But, a bankruptcy court’s constitutional authority to enter final orders is a different issue than the scope of bankruptcy subject matter jurisdiction under federal law. From the standpoint of non-consensual third-party release in plans of reorganization, Stern issues are rarely determined to be at stake.
The bankruptcy subject matter jurisdiction of district courts — and by reference bankruptcy courts — is set forth in 28 U.S.C. section 1334. The statute vests authority in such courts to have original, and in some circumstances exclusive, jurisdiction over all cases arising under, arising in, or related to cases under title 11 of the U.S. Code. The scope of the jurisdiction is quite broad and includes any matter that might have a conceivable impact on a bankruptcy debtor’s estate.
In the Purdue matter, each of the courts addressing the third-party release issue spent a relatively short amount of time on subject matter jurisdiction. This was because the courts agreed that the releases at issue met the requirement of having a conceivable effect on Purdue. That said, while the courts did not frame this dispute as a jurisdiction matter, it is notable that courts do not appear to have any issue with the fact that the far-reaching subject matter jurisdiction of bankruptcy courts radiates out to cover claims asserted against nondebtors.
The Statutory Dispute
Purdue is one of a number of recent Chapter 11 cases dealing with mass torts. The issue of whether such releases are proper can be traced back 35 years to the bankruptcy courts’ struggle to address another historic mass tort. In the 1988 decision Kane v. Johns-Manville Corp., the court of appeals approved a plan of reorganization for one of the world’s largest miner of asbestos and manufacturer of asbestos-related products. During the course of the case, the bankruptcy court struggled with how to address the fact that, given the long latency period for asbestos-related illnesses, it was a certainty that claimants who had been exposed to asbestos prior to the bankruptcy filing but who were not yet sick would assert claims at some point in the future. The issues relating to such “future claimants” were addressed in the plan through the creation and funding of a trust that would pay claims. The order confirming the plan set forth an injunction that “channeled” the claims of all such future claimants such that they could only look to the trust for recovery.
The Supreme Court never addressed whether such a channeling injunction was proper under the Bankruptcy Code. Instead, Congress stepped in and addressed the matter. In 1994, Congress passed Bankruptcy Code section 524(g), which allowed for Johns-Manville-type channeling injunctions. However, the statute was specifically limited to asbestos-related claims. There are some key differences between a channeling injunction covered by section 524(g) versus third-party releases proposed in Purdue. However, the fact remains that Congress has specifically “spoken” on injunctions against nondebtor parties in bankruptcy cases solely in the context of asbestos-related claims. Some of the courts prohibiting third-party releases have relied on that fact as the basis for disallowing such releases outside the context of asbestos claims.
Much of the dispute over these releases relates to the language in Bankruptcy Code section 524(e), which states that the “discharge of a debt other than the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” Courts disallowing the releases hold that this provision plainly precludes plans that “discharge the debt” of nondebtors through releases. Courts taking the contrary viewpoint read section 524(e) as definitional rather than prohibitory. That is, according to these courts, the section is describing what a discharge does not do rather than using language like “shall not,” which would bind courts. These courts also point to other sections of the Bankruptcy Code to support their position, including the apparent broad powers to carry out provisions of the Bankruptcy Code granted under section 105(a) and the power to include in a plan “any other appropriate provision not inconsistent with [other] appliable provisions” set forth in section 1123(b)(6).
The three circuits that outright prohibit non-consensual third-party releases are the Fifth, Ninth and Tenth Circuits, although the Ninth Circuit walked back its outright prohibition a few years ago in Blixseth v. Credit Suisse. The other circuits permit such releases, with varying tests to determine under what circumstances they will be allowed.
In addition, even in jurisdictions where non-consensual third-party releases are prohibited, bankruptcy lawyers have accomplished similar results in confirmed plans via ballot provisions whereby creditors either opt in or opt out of a release. It is black-letter law that any nondebtor party is entitled to enter into an agreement to waive its claim. Thus, the arguments surrounding such arrangements come down to whether opt-in or opt-out provisions truly represent a consensual waiver.
Is the Sky Falling?
Judge Robert Drain entered an order approving the Purdue bankruptcy plan, including non-consensual third-party releases of the Sacklers on Sept. 17, 2021. By that time, the Purdue case had been pending for two years and the many different parties-in-interest — including dozens of states, municipalities and Indian tribes — had engaged in two lengthy mediations by three different mediators. Judge Drain’s opinion stated that the case involved the largest creditor body ever and that the process of the parties investigating claims went through “the most extensive discovery process … any court in bankruptcy has ever seen” with the production of ten million documents comprising nearly 100 million total pages. Judge Drain further noted the applicable law in the Second Circuit — including the case In re Metromedia Fiber Network, Inc. — where non-consensual third party releases would be permitted in “limited, rare cases.” He concluded that the extraordinary circumstances presented by the opioid crisis in the Purdue case presented just such a limited and rare case.
The United States Trustee in the Second Circuit consistently opposed the imposition of the releases, arguing that they were not permitted under the Bankruptcy Code. The U.S. Trustee and a handful of other parties appealed the case to the District Court. On Dec. 21, 2021, the District Court entered a 76-page memorandum opinion reversing the Bankruptcy Court’s holding. District Judge Colleen McMahon sympathized with the desire to pay claimants and complemented Judge Drain on his diligence in an extremely difficult case. But, she ultimately determined, after a one-by-one analysis of each provision of the Bankruptcy Code allegedly providing authority to grant such releases, that the statutory authority was lacking. She further held that the Metromedia case “said a great deal [but] did not hold much of anything” and that it was not otherwise relevant to the case at hand.
The case was appealed to the Second Circuit Court of Appeals and argument was held on April 29, 2022. For nearly a year, the bankruptcy community waited with bated breath for this important decision. On May 30 of this year, the court ruled. It overturned the District Court, finding that section 524(e) was no bar and that section 1126(b)(6) permitted the releases. The celebrations among the Purdue plan supporters lasted until Aug. 10, when the Supreme Court entered its order granting a writ of certiorari. Among parties who believe non-consensual third-party releases are critical to Chapter 11 bankruptcy practice, the celebratory mood has been replaced with consternation.
Of course, it remains to be seen how the Supreme Court will rule in the Purdue matter. However, the sport of predicting what will happen if the court rules in a particular manner is well under way among bankruptcy practitioners. A vocal group has cautioned that third-party releases have become standard in large Chapter 11 confirmation plans and that a ruling by the Supreme Court generally disallowing such releases would have catastrophic effects on the utility of Chapter 11. Another common topic of discussion is whether mass tort cases can be handled effectively in bankruptcy court if the Supreme Court removes this item from the Chapter 11 toolbox.
This hand wringing seems a little overwrought. For one thing, the case law in jurisdictions allowing these releases clearly provides that non-consensual third-party releases should only be allowed in extraordinary circumstances. It is difficult to reconcile that fact with statements that such releases are, or should be, normal practice in most every complicated Chapter 11 case. In addition, certain jurisdictions where non-consensual third-party releases are prohibited — most notably the Southern District of Texas — are routinely confirming Chapter 11 plans in complicated cases.
The trajectory of the Supreme Court’s 2011 Stern v. Marshall decision provides a model of how the Supreme Court’s decision in Purdue may play out. First, there is a short period immediately following the Supreme Court’s opinion where Chapter 11 is pronounced dead by commentators. This is followed by more even-keeled analysis, and ultimately lower court guidance, whereby Chapter 11 remains an important and useful tool for reorganizing the debts of complicated businesses.
Jason B. Binford is a shareholder in the Austin office of the corporate restructuring, bankruptcy, insolvency and mediation firm Ross, Smith & Binford, PC.