Bankruptcy Industry Update
Recent Rulings on 3rd-Party Releases, Texas 2-Step Cases Paint Mixed Picture: Is Bankruptcy More Equitable Path to Compensation Than ‘Lottery’ of Tort System or Are Nondebtor Protections ‘Abuse’ of Process?
Mon 02/28/2022 17:03 PM
Should bankruptcy protections extend to companies and individuals in a chapter 11 debtor’s orbit that have not filed for bankruptcy themselves? After the issue drew a firestorm of attention from legislators and commentators, several recent court decisions - Purdue Pharma, Ascena Retail, Mallinckrodt and LTL Management - provide a mixed answer. District court judges struck down third-party releases in the Purdue and Ascena plans, but in the wake of those decisions, Delaware Bankruptcy Judge John Dorsey went the other way, approving such releases in the Mallinckrodt case.
In a variation on this theme, last week the New Jersey bankruptcy court denied talc claimants’ requests to dismiss LTL Management’s “Texas two-step” chapter 11 case as a bad-faith attempt to extend bankruptcy protections to parent Johnson & Johnson. Judge Michael Kaplan expressed confidence that the bankruptcy court is the “optimal venue” for resolving mass talc claims, against talc claimants’ arguments that they should be able to continue litigation against J&J and LTL in the tort system - the state courts or the multidistrict talc litigation pending in New Jersey federal court, for example.
These decisions discuss the concerns at the heart of the debate over protections for nondebtors: the jurisdictional limitations of bankruptcy courts as Article I tribunals, the practical aims of complex commercial reorganizations, and whether victims of mass torts fare better in the tort system or in the bankruptcy courts.
Chapter 11 plans in some of the busiest venues for large corporate reorganizations, including the Southern District of New York and Delaware, have long included third-party releases - releases of claims held by nondebtors against other nondebtors - typically in favor of the debtors’ officers, directors, professionals and equity sponsors. As part of the chapter 11 plan confirmation process, courts in these jurisdictions commonly approve releases of nonbankruptcy claims against nondebtors that would otherwise be prosecuted in courts of general jurisdiction (and often before a jury).
However, whether bankruptcy courts have authority to grant releases and affect third parties’ rights is murky because the Bankruptcy Code does not explicitly authorize such releases. Apart from the asbestos liability context (where nondebtor releases are specifically set out in section 524(g)), the Bankruptcy Code does not include any specific authorization for bankruptcy courts to grant nonconsensual nondebtor releases and only provides for discharge of claims against debtors.
The U.S. Courts of Appeals are divided on the question. The Fifth, Ninth and Tenth Circuits have held that bankruptcy courts lack authority to grant nondebtor releases in non-asbestos cases. However, a majority of the circuit courts, including the First, Third, Fourth, Sixth, Seventh and Eleventh Circuits, permit channeling injunctions and nondebtor third-party releases in some form - although they generally agree that nondebtor releases should be deployed sparingly and only in exceptional circumstances. Despite this stricture, bankruptcy courts routinely issue nondebtor releases in virtually every large chapter 11 case. Acknowledging this paradox, Southern District of New York Judge Colleen McMahon put it in her Dec. 16, 2021, ruling vacating the Purdue confirmation order: “When every case is unique, none is unique.”
In her Purdue opinion, Judge McMahon surveys the positions taken in the circuit court split, as detailed in the below chart. Some circuits entirely reject nondebtor releases outside of the asbestos process; others find the releases are authorized under various sections of the Bankruptcy Code and under bankruptcy courts’ “residual authority”; and some circuits have yet to consider the issue.
Judge McMahon ultimately agreed with the minority position that the Bankruptcy Code does not provide statutory authorization to approve nonconsensual nondebtor releases outside of the asbestos context. Further, Judge McMahon concluded that the bankruptcy court lacks authority to enter a final order approving such releases under the U.S. Supreme Court’s 2011 Stern v. Marshall decision.
In Ascena, Eastern District of Virginia Judge David Novak agreed with Judge McMahon that the bankruptcy court “plainly lacked the constitutional power to adjudicate” claims covered by the third-party releases in the Ascena plan. Judge Novak also reversed the bankruptcy court’s conclusion that the releases in question were consensual, finding the debtors’ opt-out mechanism (a common workaround for the legal issues with nonconsensual nondebtor releases) insufficient to constitute consent to either the jurisdiction of the bankruptcy court as a non-Article III court or to the releases themselves. Judge Novak also took issue with the Richmond bankruptcy judges’ liberal approval of nondebtor releases, suggesting that the “rare case” exception had swallowed the general rule against approval.
In Mallinckrodt, Delaware Bankruptcy Judge Dorsey sidestepped the Purdue and Ascena decisions as precedent from different circuits. The judge remarked, “There can be no debate over the proposition that a bankruptcy court can approve a plan that includes third-party releases” in the Third Circuit. In confirming Mallinckrodt’s plan, Judge Dorsey approved both the nonconsensual release of opioid claims and the release of non-opioid claims, finding the latter consensual in light of an opt-out mechanism. Unlike the Purdue and Ascena rulings, which found that the nonconsensual releases in those cases effectively extinguished third-party claims, Judge Dorsey wrote, “I disagree with the notion that releases are the equivalent of a discharge.”
New Jersey Bankruptcy Judge Michael Kaplan’s LTL Management ruling last Friday, Feb. 25, tackled the issue of bankruptcy abuse from a different angle: the controversial “Texas two-step” strategy. Mass tort claimants in LTL, as well as several North Carolina cases including DBMP, Aldrich Pump and Bestwall, have decried the restructuring maneuver as a bad-faith attempt to protect corporate affiliates and limit recoveries to victims. However, Judge Kaplan denied talc claimants’ motions to toss the LTL case out of bankruptcy court, finding that chapter 11 provided a “more beneficial and equitable path toward resolving Debtor’s ongoing talc-related liabilities” than the tort system, which LTL has described as “lottery-like.”
Judge Kaplan wrote that he “simply cannot accept the premise that continued litigation in state and federal courts serves best the interest of” talc claimants. On the same day, the judge extended a preliminary injunction shielding “protected parties” including parent J&J from talc litigation through late June.
In addition to discussing the Purdue, Ascena, Mallinckrodt and LTL decisions, this article highlights proposed legislation, a number of recent and ongoing cases involving third-party releases and considers the relevance of other nondebtor protections in additional “Texas two-step” bankruptcies. The specter of abuse of the bankruptcy process by nondebtors will continue to play out both inside and outside the courts, with Congress considering the Nondebtor Release Prohibition Act.
Reorg discussed third-party releases and the Texas two-step strategy in a recent Deep Dive podcast, available HERE. As described below, Reorg has also compiled a list of chapter 11 cases since 2020 from our restructuring database in which stakeholders or parties in interest filed objections to a debtor’s plan confirmation based on the plan’s inclusion of third-party releases. The restructuring dataset will soon be incorporated into Credit Cloud.
State of the Law
Circuit Summary* (as characterized by Judge McMahon):
Recent Decisions
Cases Under Discussion:
Next Steps
Purdue Pharma
In the wake of Judge McMahon’s decision invalidating the Sackler release, Purdue has undertaken a dual-track process: appealing the ruling while also engaging in plan negotiations with other case parties. The Second Circuit accepted Purdue and other plan supporters’ appeal of the ruling on an expedited briefing schedule and with oral argument during the week of April 25 “or as soon thereafter as practicable.”
In the meantime, the Sackler family and the objecting states group have made strides in mediation. On Feb. 18, an interim report from mediator Judge Shelley Chapman announced that a “supermajority” of the objecting states had accepted a settlement proposal that would require the Sackler families to pay at least $5.5 billion and up to $6 billion, up from the $4.325 billion previously agreed to. However, the proposal is conditioned on acceptance by all mediation parties. Mediation has since been extended to Feb. 28. Reorg discussed the settlement negotiation process in the Purdue case in the latest installment of the Court Opinion Review.
The precise contours of a settlement between objecting states and the Sacklers are unclear. Judge McMahon’s opinion invalidated the nonconsensual release of all “direct” third-party claims against the Sacklers, not just those held by the mediation parties. Although the objecting states may very well be the largest holders of such direct claims, scores of other creditors that voted to reject the plan could conceivably hold such claims as well. Public disclosures have not yet revealed whether the mediation parties agreed to carve out the direct claims that Judge McMahon ruled could not be released. Moreover, the U.S. Trustee has not remarked publicly on whether it would continue to oppose the Purdue plan if the Sacklers increase their settlement contribution.
Ascena
Judge Novak remanded the case to the bankruptcy court to narrow the plan’s exculpation provision “and then to proceed with confirmation of the Plan without the voided Third-Party Releases.” The judge’s remand instructions came with a harsh critique of the Richmond bankruptcy judges’ collective handling of third-party releases. Judge Novak directed that the case be reassigned to another bankruptcy judge in the district outside of the Richmond Division. He admonished that, “the practice of regularly approving third-party releases and the related concerns about forum shopping call into question public confidence in the manner that these cases are being handled by the Bankruptcy Court in the Richmond Division.”
Confirming Judge Novak’s belief that the plan was viable without the third-party releases, the debtors have opted not to appeal the decision and instead are proceeding with “reconfirmation” of the plan minus the releases and with a tailored exculpation provision. The debtors’ hearing on reconfirmation is scheduled for March 3 at 2 p.m. ET.
Mallinckrodt
Although the confirmation order has not yet been entered in the case, a number of parties have appealed Judge Dorsey’s confirmation ruling. However, as yet, none of the appeals have focused on the third-party releases, and the U.S. Trustee has not indicated if it will press its objection on appeal.
Judge Dorsey’s decision in Mallinckrodt offers a significant counterpoint to the Purdue and Ascena cases, affirming the continued viability of nonconsensual third-party releases in Delaware and the district’s tolerance of opt-out procedures. Judge Dorsey also made it clear that he believes the bankruptcy court has the constitutional authority to enter a final order approving such releases. Against that backdrop, the Delaware bankruptcy courts may regain ground lost in the venue competition with the Eastern District of Virginia and Southern District of New York courts.
LTL Management and Other Texas Two-Step Cases
Reorg has been covering the “Texas two-step” cases of DBMP, Aldrich Pump and Bestwall, all spun-off entities created via a Texas divisional merger to cabin asbestos liabilities that then filed for chapter 11 in the Western District of North Carolina. Efforts to avoid or unwind the transactions are underway, with the asbestos claimants committees in those cases seeking a variety of litigation tactics, including substantive consolidation and fraudulent transfer actions. The Bestwall asbestos claimants recently lost their district court appeal of the Charlotte bankruptcy court’s issuance of a preliminary injunction protecting nondebtor affiliates.
But the chapter 11 case of J&J subsidiary LTL Management (created to house the talc liabilities of its predecessor, “old” Johnson & Johnson Consumer Inc., or old JJCI) has pulled the Texas two-step maneuver further into the spotlight. LTL’s talc claimants - joined by a small army of legal scholars - relied on Purdue in calling for the case to be dismissed. The talc claimants argue that J&J is abusing the bankruptcy system by reaping the Bankruptcy Code’s protections without having to shoulder the burden of undertaking its own bankruptcy proceeding. Talc claimants also objected to the extension of a preliminary injunction shielding J&J and other “protected parties,” including certain retailers and insurers, from talc litigation.
Judge Michael Kaplan overruled these arguments in a pair of decisions last Friday, Feb. 25, in which he denied motions to dismiss the LTL chapter 11 case filed by the official talc claimants committee and personal injury law firm Aylstock Witkin Kreis & Overholtz and extended the preliminary injunction through June 29.
Judge Kaplan rejected the movants’ argument that LTL’s chapter 11 case was filed in bad faith. “Let’s be clear,” he wrote, “the filing of a chapter 11 case with the expressed aim of addressing the present and future liabilities associated with ongoing global personal injury claims to preserve corporate value is unquestionably a proper purpose under the Bankruptcy Code” (emphasis added). The fact that J&J and old JJCI would seek to limit exposure to present and future claims was “unsurprising” and, standing alone, insufficient to establish bad faith, the opinion stated.
The judge said there was no doubt that “our bankruptcy courts have witnessed serious abuses and inefficiencies.” As examples, he pointed to “overly broad nonconsensual third-party releases, and the propriety/necessity for twenty-four hour accelerated bankruptcy cases” as issues that have “drawn deserved scrutiny.” Nevertheless, Judge Kaplan found that the use of the Texas two-step strategy in the LTL case was not an abusive litigation tactic and expressed doubt that talc claimants would fare better in the tort system, calling the bankruptcy process the “optimal venue for redressing the harms of both present and future talc claimants in this case - ensuring a meaningful, timely, and equitable recovery.”
Looking forward, the judge also rejected the movants’ argument that J&J and new JJCI will escape scrutiny as a result of LTL’s case: “Given what will be required to confirm a plan in this case, as well as the attention this case is receiving from the public, media, government regulators, policy makers - let alone the Court, the United States Trustee and the dozens of attorneys involved - the Court is disinclined to view any of these entities as escaping the scrutiny or burdens” of bankruptcy, he wrote.
In the wake of Judge Kaplan’s decisions, LTL’s mesothelioma claimants committee said that it is “exploring available legal options and avenues of appeal.”
Related Issue Survey
Recent Cases
Until definitive guidance from the Supreme Court arrives, approval of less contentious third-party releases continues apace. Recently, Southern District of New York Bankruptcy Judge Michael Wiles confirmed the GBG debtors’ liquidating plan over an objection of the UST relying upon the Purdue district court decision. Judge Wiles determined the third-party release mechanics - requiring either a “yes” vote on the plan or an “opt-in” to the releases - were consensual and did not require a separate opt-in for creditors voting in favor of the plan. Another recent case before Judge Wiles, Vewd Software, was confirmed after the UST indicated it would not object to the consensual third-party releases contained in the plan. These cases may provide early insight into a potential policy decision by the Region 2 office of the UST not to press Stern-based objections to a bankruptcy court’s authority to enter final orders approving releases.
Cases to Watch
The Boy Scouts of America case, pending in the Delaware bankruptcy court before Judge Laurie Selber Silverstein, promises to shine a spotlight again on the propriety of third-party releases. The Boy Scouts plan proposes to resolve abuse-related claims against the organization through a plan of reorganization that “equitably” compensates victims through a trust structure, and, like Purdue and other cases reviewed here, provides for a channeling injunction and nonconsensual third-party releases.
The UST has objected to the plan’s proposed nonconsensual releases as overly broad. The provision would violate the U.S. Constitution’s Due Process Clause and the court lacks statutory under the Bankruptcy Code to approve it, the UST argues. The official committee of tort claimants, or TCC, has taken a different tack, asserting that the releases are theoretically permissible but require “overwhelming” approval by at least 90% of affected creditors under the Third Circuit’s Continental decision. The debtors have taken the position that the then current approval by approximately 73% of holders of direct abuse claims was sufficient under the standard thresholds for plan confirmation.
The plan confirmation process is in flux with the Boy Scouts debtors recently filing a fifth amended plan incorporating a settlement with the TCC. Voting has been reopened through a supplemental plan notice process, and the confirmation hearing is currently scheduled for March 14.
Legislative Action
As mentioned above, Congress has also taken note of the controversy over third-party releases and the Texas two-step. The Nondebtor Release Prohibition Act was introduced in July 2021, before LTL’s chapter 11 filing but shortly after rumors started circulating that J&J was considering employing the Texas two-step. The strategy was the subject of recent debate on Capitol Hill as Texas two-step opponents faced off with defenders at a Feb. 8 Senate Judiciary Committee hearing on the Nondebtor Release Prohibition Act.
Restructuring Dataset
Reorg has compiled a list of chapter 11 cases since 2020 in which certain stakeholders or parties in interest filed objections to a debtor’s plan confirmation based on the plan’s inclusion of third-party releases. The list does not include objections made by the UST.
The data and list of companies in which plan stakeholders filed plan confirmation objections based in whole or in part on third-party releases can be found in a restructuring dataset, which includes bankruptcies since 2020, compiled by Reorg. A link to the search can be found HERE and an excerpt of the table is below:
The restructuring dataset will soon be incorporated into Credit Cloud. The portal can be found HERE.
--Michael Legge, Karen Leung, David Mayo
In a variation on this theme, last week the New Jersey bankruptcy court denied talc claimants’ requests to dismiss LTL Management’s “Texas two-step” chapter 11 case as a bad-faith attempt to extend bankruptcy protections to parent Johnson & Johnson. Judge Michael Kaplan expressed confidence that the bankruptcy court is the “optimal venue” for resolving mass talc claims, against talc claimants’ arguments that they should be able to continue litigation against J&J and LTL in the tort system - the state courts or the multidistrict talc litigation pending in New Jersey federal court, for example.
These decisions discuss the concerns at the heart of the debate over protections for nondebtors: the jurisdictional limitations of bankruptcy courts as Article I tribunals, the practical aims of complex commercial reorganizations, and whether victims of mass torts fare better in the tort system or in the bankruptcy courts.
Chapter 11 plans in some of the busiest venues for large corporate reorganizations, including the Southern District of New York and Delaware, have long included third-party releases - releases of claims held by nondebtors against other nondebtors - typically in favor of the debtors’ officers, directors, professionals and equity sponsors. As part of the chapter 11 plan confirmation process, courts in these jurisdictions commonly approve releases of nonbankruptcy claims against nondebtors that would otherwise be prosecuted in courts of general jurisdiction (and often before a jury).
However, whether bankruptcy courts have authority to grant releases and affect third parties’ rights is murky because the Bankruptcy Code does not explicitly authorize such releases. Apart from the asbestos liability context (where nondebtor releases are specifically set out in section 524(g)), the Bankruptcy Code does not include any specific authorization for bankruptcy courts to grant nonconsensual nondebtor releases and only provides for discharge of claims against debtors.
The U.S. Courts of Appeals are divided on the question. The Fifth, Ninth and Tenth Circuits have held that bankruptcy courts lack authority to grant nondebtor releases in non-asbestos cases. However, a majority of the circuit courts, including the First, Third, Fourth, Sixth, Seventh and Eleventh Circuits, permit channeling injunctions and nondebtor third-party releases in some form - although they generally agree that nondebtor releases should be deployed sparingly and only in exceptional circumstances. Despite this stricture, bankruptcy courts routinely issue nondebtor releases in virtually every large chapter 11 case. Acknowledging this paradox, Southern District of New York Judge Colleen McMahon put it in her Dec. 16, 2021, ruling vacating the Purdue confirmation order: “When every case is unique, none is unique.”
In her Purdue opinion, Judge McMahon surveys the positions taken in the circuit court split, as detailed in the below chart. Some circuits entirely reject nondebtor releases outside of the asbestos process; others find the releases are authorized under various sections of the Bankruptcy Code and under bankruptcy courts’ “residual authority”; and some circuits have yet to consider the issue.
Judge McMahon ultimately agreed with the minority position that the Bankruptcy Code does not provide statutory authorization to approve nonconsensual nondebtor releases outside of the asbestos context. Further, Judge McMahon concluded that the bankruptcy court lacks authority to enter a final order approving such releases under the U.S. Supreme Court’s 2011 Stern v. Marshall decision.
In Ascena, Eastern District of Virginia Judge David Novak agreed with Judge McMahon that the bankruptcy court “plainly lacked the constitutional power to adjudicate” claims covered by the third-party releases in the Ascena plan. Judge Novak also reversed the bankruptcy court’s conclusion that the releases in question were consensual, finding the debtors’ opt-out mechanism (a common workaround for the legal issues with nonconsensual nondebtor releases) insufficient to constitute consent to either the jurisdiction of the bankruptcy court as a non-Article III court or to the releases themselves. Judge Novak also took issue with the Richmond bankruptcy judges’ liberal approval of nondebtor releases, suggesting that the “rare case” exception had swallowed the general rule against approval.
In Mallinckrodt, Delaware Bankruptcy Judge Dorsey sidestepped the Purdue and Ascena decisions as precedent from different circuits. The judge remarked, “There can be no debate over the proposition that a bankruptcy court can approve a plan that includes third-party releases” in the Third Circuit. In confirming Mallinckrodt’s plan, Judge Dorsey approved both the nonconsensual release of opioid claims and the release of non-opioid claims, finding the latter consensual in light of an opt-out mechanism. Unlike the Purdue and Ascena rulings, which found that the nonconsensual releases in those cases effectively extinguished third-party claims, Judge Dorsey wrote, “I disagree with the notion that releases are the equivalent of a discharge.”
New Jersey Bankruptcy Judge Michael Kaplan’s LTL Management ruling last Friday, Feb. 25, tackled the issue of bankruptcy abuse from a different angle: the controversial “Texas two-step” strategy. Mass tort claimants in LTL, as well as several North Carolina cases including DBMP, Aldrich Pump and Bestwall, have decried the restructuring maneuver as a bad-faith attempt to protect corporate affiliates and limit recoveries to victims. However, Judge Kaplan denied talc claimants’ motions to toss the LTL case out of bankruptcy court, finding that chapter 11 provided a “more beneficial and equitable path toward resolving Debtor’s ongoing talc-related liabilities” than the tort system, which LTL has described as “lottery-like.”
Judge Kaplan wrote that he “simply cannot accept the premise that continued litigation in state and federal courts serves best the interest of” talc claimants. On the same day, the judge extended a preliminary injunction shielding “protected parties” including parent J&J from talc litigation through late June.
In addition to discussing the Purdue, Ascena, Mallinckrodt and LTL decisions, this article highlights proposed legislation, a number of recent and ongoing cases involving third-party releases and considers the relevance of other nondebtor protections in additional “Texas two-step” bankruptcies. The specter of abuse of the bankruptcy process by nondebtors will continue to play out both inside and outside the courts, with Congress considering the Nondebtor Release Prohibition Act.
Reorg discussed third-party releases and the Texas two-step strategy in a recent Deep Dive podcast, available HERE. As described below, Reorg has also compiled a list of chapter 11 cases since 2020 from our restructuring database in which stakeholders or parties in interest filed objections to a debtor’s plan confirmation based on the plan’s inclusion of third-party releases. The restructuring dataset will soon be incorporated into Credit Cloud.
State of the Law
Circuit Summary* (as characterized by Judge McMahon):
| Jurisdiction | Cases | Position on Third-Party Releases* |
| Second Circuit | In re Metromedia Fiber Network, Inc., 416 F. 3d 136, 141 (2d Cir. 2005) | Indicated that nonconsensual nondebtor releases in “‘appropriate, narrow circumstances,’” but “disposed of the case on other grounds, without identifying what section or sections of the Bankruptcy Code might actually authorize such relief in non-asbestos bankruptcy.” |
| Third Circuit | In re Millennium Lab Holdings II, LLC, 945 F.3d 126, 133-40 (3d Cir. 2019). | Concluded that “the bankruptcy court had constitutional authority to extinguish certain third-party claims” in connection with plan confirmation but did “not discuss statutory authority.” |
| Fifth, Ninth and Tenth Circuits | In re Pacific Lumber Co., 584 F.3d 229, 252 (5th Cir. 2009); In re Lowenschuss, 67 F.3d 1394, 1401-02 (9th Cir. 1995); In re W. Real Estate Fund, 922 F.2d 592, 600 (10th Cir. 1990) | Rejected entirely “the notion that a court can authorize non-debtor releases outside the asbestos context.” |
| Fourth and Eleventh Circuits | Nat’l Heritage Found., Inc. v. Highbourne Found., Inc., 760 F.3d 344, 350 (4th Cir. 2014); In re Seaside Eng’g & Surveying, 780 F.3d 1070, 1076-79 (11th Cir. 2015) | Found that general bankruptcy court equitable authority under Section 105 of Bankruptcy Code, “without more, authorizes such releases.” |
| Sixth and Seventh Circuits | In re Dow Corning Corp., 280 F.3d 648, 661 (6th Cir. 2012); In re Airadigm Communications, Inc., 519 F. 3d 640, 657 (7th Cir. 2008) | Concluded that “[s]ections 105(a) and 1123(b)(6) … codify … a bankruptcy court’s ‘residual authority,’ through which ‘a bankruptcy court can impose nonconsensual releases of third-party claims against non-debtors in connection with a chapter 11 plan.” |
| First, Eighth and D.C. Circuits | “[Y]et to weigh in on the question of whether statutory authority to impose non-debtor releases exists.” |
Recent Decisions
Cases Under Discussion:
| Purdue | Ascena | Mallinckrodt | |
| Judge | Judge Colleen McMahon | Judge David Novak | Judge John Dorsey |
|---|---|---|---|
| Jurisdiction | District Court for the Southern District of New York (Second Circuit) | District Court for the Eastern District of Virginia (Fourth Circuit) | Bankruptcy Court for the District of Delaware (Third Circuit) |
| Position on nondebtor releases | Concludes there is no statutory authority to approve nonconsensual nondebtor releases in the Bankruptcy Code. Bankruptcy court’s jurisdiction over a third-party release, if statutorily authorized, would be “related-to” and not “core,” requiring final approval by an Article III court under Stern. |
Bankruptcy court lacks statutory authority to approve nonconsensual nondebtor releases under Stern. Rejected debtors’ argument that releases were necessary to reorganization and thus nonseverable from rest of plan. Severed releases as failing to meet the Fourth Circuit standard for approval, citing Behrmann v Nat’l Heritage Foundation, 663 F.3d 704 (4th Cir. 2011). |
Bankruptcy courts have authority to approve plans of reorganization that contain nonconsensual nondebtor when “necessary and fair” in “exceptional” circumstances under section 105, citing Third Circuit’s 2019 Millennium, and In re Continental, 203 F.3d 203 (3rd Cir. 2000), decisions. |
| Position on consent / opt-out mechanism | Debtors conceded releases were nonconsensual. | Debtors argued releases consensual for releasing parties who failed to opt out, court found opt-out mechanism insufficient to establish consent. | Rejected Ascena, concluded opt-out mechanism rendered the third-party release of non-opioid claims consensual. |
Next Steps
Purdue Pharma
In the wake of Judge McMahon’s decision invalidating the Sackler release, Purdue has undertaken a dual-track process: appealing the ruling while also engaging in plan negotiations with other case parties. The Second Circuit accepted Purdue and other plan supporters’ appeal of the ruling on an expedited briefing schedule and with oral argument during the week of April 25 “or as soon thereafter as practicable.”
In the meantime, the Sackler family and the objecting states group have made strides in mediation. On Feb. 18, an interim report from mediator Judge Shelley Chapman announced that a “supermajority” of the objecting states had accepted a settlement proposal that would require the Sackler families to pay at least $5.5 billion and up to $6 billion, up from the $4.325 billion previously agreed to. However, the proposal is conditioned on acceptance by all mediation parties. Mediation has since been extended to Feb. 28. Reorg discussed the settlement negotiation process in the Purdue case in the latest installment of the Court Opinion Review.
The precise contours of a settlement between objecting states and the Sacklers are unclear. Judge McMahon’s opinion invalidated the nonconsensual release of all “direct” third-party claims against the Sacklers, not just those held by the mediation parties. Although the objecting states may very well be the largest holders of such direct claims, scores of other creditors that voted to reject the plan could conceivably hold such claims as well. Public disclosures have not yet revealed whether the mediation parties agreed to carve out the direct claims that Judge McMahon ruled could not be released. Moreover, the U.S. Trustee has not remarked publicly on whether it would continue to oppose the Purdue plan if the Sacklers increase their settlement contribution.
Ascena
Judge Novak remanded the case to the bankruptcy court to narrow the plan’s exculpation provision “and then to proceed with confirmation of the Plan without the voided Third-Party Releases.” The judge’s remand instructions came with a harsh critique of the Richmond bankruptcy judges’ collective handling of third-party releases. Judge Novak directed that the case be reassigned to another bankruptcy judge in the district outside of the Richmond Division. He admonished that, “the practice of regularly approving third-party releases and the related concerns about forum shopping call into question public confidence in the manner that these cases are being handled by the Bankruptcy Court in the Richmond Division.”
Confirming Judge Novak’s belief that the plan was viable without the third-party releases, the debtors have opted not to appeal the decision and instead are proceeding with “reconfirmation” of the plan minus the releases and with a tailored exculpation provision. The debtors’ hearing on reconfirmation is scheduled for March 3 at 2 p.m. ET.
Mallinckrodt
Although the confirmation order has not yet been entered in the case, a number of parties have appealed Judge Dorsey’s confirmation ruling. However, as yet, none of the appeals have focused on the third-party releases, and the U.S. Trustee has not indicated if it will press its objection on appeal.
Judge Dorsey’s decision in Mallinckrodt offers a significant counterpoint to the Purdue and Ascena cases, affirming the continued viability of nonconsensual third-party releases in Delaware and the district’s tolerance of opt-out procedures. Judge Dorsey also made it clear that he believes the bankruptcy court has the constitutional authority to enter a final order approving such releases. Against that backdrop, the Delaware bankruptcy courts may regain ground lost in the venue competition with the Eastern District of Virginia and Southern District of New York courts.
LTL Management and Other Texas Two-Step Cases
Reorg has been covering the “Texas two-step” cases of DBMP, Aldrich Pump and Bestwall, all spun-off entities created via a Texas divisional merger to cabin asbestos liabilities that then filed for chapter 11 in the Western District of North Carolina. Efforts to avoid or unwind the transactions are underway, with the asbestos claimants committees in those cases seeking a variety of litigation tactics, including substantive consolidation and fraudulent transfer actions. The Bestwall asbestos claimants recently lost their district court appeal of the Charlotte bankruptcy court’s issuance of a preliminary injunction protecting nondebtor affiliates.
But the chapter 11 case of J&J subsidiary LTL Management (created to house the talc liabilities of its predecessor, “old” Johnson & Johnson Consumer Inc., or old JJCI) has pulled the Texas two-step maneuver further into the spotlight. LTL’s talc claimants - joined by a small army of legal scholars - relied on Purdue in calling for the case to be dismissed. The talc claimants argue that J&J is abusing the bankruptcy system by reaping the Bankruptcy Code’s protections without having to shoulder the burden of undertaking its own bankruptcy proceeding. Talc claimants also objected to the extension of a preliminary injunction shielding J&J and other “protected parties,” including certain retailers and insurers, from talc litigation.
Judge Michael Kaplan overruled these arguments in a pair of decisions last Friday, Feb. 25, in which he denied motions to dismiss the LTL chapter 11 case filed by the official talc claimants committee and personal injury law firm Aylstock Witkin Kreis & Overholtz and extended the preliminary injunction through June 29.
Judge Kaplan rejected the movants’ argument that LTL’s chapter 11 case was filed in bad faith. “Let’s be clear,” he wrote, “the filing of a chapter 11 case with the expressed aim of addressing the present and future liabilities associated with ongoing global personal injury claims to preserve corporate value is unquestionably a proper purpose under the Bankruptcy Code” (emphasis added). The fact that J&J and old JJCI would seek to limit exposure to present and future claims was “unsurprising” and, standing alone, insufficient to establish bad faith, the opinion stated.
The judge said there was no doubt that “our bankruptcy courts have witnessed serious abuses and inefficiencies.” As examples, he pointed to “overly broad nonconsensual third-party releases, and the propriety/necessity for twenty-four hour accelerated bankruptcy cases” as issues that have “drawn deserved scrutiny.” Nevertheless, Judge Kaplan found that the use of the Texas two-step strategy in the LTL case was not an abusive litigation tactic and expressed doubt that talc claimants would fare better in the tort system, calling the bankruptcy process the “optimal venue for redressing the harms of both present and future talc claimants in this case - ensuring a meaningful, timely, and equitable recovery.”
Looking forward, the judge also rejected the movants’ argument that J&J and new JJCI will escape scrutiny as a result of LTL’s case: “Given what will be required to confirm a plan in this case, as well as the attention this case is receiving from the public, media, government regulators, policy makers - let alone the Court, the United States Trustee and the dozens of attorneys involved - the Court is disinclined to view any of these entities as escaping the scrutiny or burdens” of bankruptcy, he wrote.
In the wake of Judge Kaplan’s decisions, LTL’s mesothelioma claimants committee said that it is “exploring available legal options and avenues of appeal.”
Related Issue Survey
Recent Cases
Until definitive guidance from the Supreme Court arrives, approval of less contentious third-party releases continues apace. Recently, Southern District of New York Bankruptcy Judge Michael Wiles confirmed the GBG debtors’ liquidating plan over an objection of the UST relying upon the Purdue district court decision. Judge Wiles determined the third-party release mechanics - requiring either a “yes” vote on the plan or an “opt-in” to the releases - were consensual and did not require a separate opt-in for creditors voting in favor of the plan. Another recent case before Judge Wiles, Vewd Software, was confirmed after the UST indicated it would not object to the consensual third-party releases contained in the plan. These cases may provide early insight into a potential policy decision by the Region 2 office of the UST not to press Stern-based objections to a bankruptcy court’s authority to enter final orders approving releases.
Cases to Watch
The Boy Scouts of America case, pending in the Delaware bankruptcy court before Judge Laurie Selber Silverstein, promises to shine a spotlight again on the propriety of third-party releases. The Boy Scouts plan proposes to resolve abuse-related claims against the organization through a plan of reorganization that “equitably” compensates victims through a trust structure, and, like Purdue and other cases reviewed here, provides for a channeling injunction and nonconsensual third-party releases.
The UST has objected to the plan’s proposed nonconsensual releases as overly broad. The provision would violate the U.S. Constitution’s Due Process Clause and the court lacks statutory under the Bankruptcy Code to approve it, the UST argues. The official committee of tort claimants, or TCC, has taken a different tack, asserting that the releases are theoretically permissible but require “overwhelming” approval by at least 90% of affected creditors under the Third Circuit’s Continental decision. The debtors have taken the position that the then current approval by approximately 73% of holders of direct abuse claims was sufficient under the standard thresholds for plan confirmation.
The plan confirmation process is in flux with the Boy Scouts debtors recently filing a fifth amended plan incorporating a settlement with the TCC. Voting has been reopened through a supplemental plan notice process, and the confirmation hearing is currently scheduled for March 14.
Legislative Action
As mentioned above, Congress has also taken note of the controversy over third-party releases and the Texas two-step. The Nondebtor Release Prohibition Act was introduced in July 2021, before LTL’s chapter 11 filing but shortly after rumors started circulating that J&J was considering employing the Texas two-step. The strategy was the subject of recent debate on Capitol Hill as Texas two-step opponents faced off with defenders at a Feb. 8 Senate Judiciary Committee hearing on the Nondebtor Release Prohibition Act.
Restructuring Dataset
Reorg has compiled a list of chapter 11 cases since 2020 in which certain stakeholders or parties in interest filed objections to a debtor’s plan confirmation based on the plan’s inclusion of third-party releases. The list does not include objections made by the UST.
The data and list of companies in which plan stakeholders filed plan confirmation objections based in whole or in part on third-party releases can be found in a restructuring dataset, which includes bankruptcies since 2020, compiled by Reorg. A link to the search can be found HERE and an excerpt of the table is below:
The restructuring dataset will soon be incorporated into Credit Cloud. The portal can be found HERE.
--Michael Legge, Karen Leung, David Mayo
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