Relevant Documents:OpinionConcurring OpinionJudgment
In a long-awaited opinion arising out of the Purdue Pharma bankruptcy, the U.S. Court of Appeals for the Second Circuit has upheld bankruptcy courts’ authority to approve
nonconsensual third-party releases in chapter 11 plans. Reversing a
controversial ruling from Judge Colleen McMahon of the U.S. District Court for the Southern District of New York, the circuit court finds that the bankruptcy court had jurisdiction and authority under the Bankruptcy Code to release creditors’ direct claims against Purdue’s owners - members of the Sackler family - when it
confirmed Purdue’s plan.
The Second Circuit concludes that its own “precedents permit the imposition of nonconsensual third-party releases” - a repudiation of Judge McMahon’s view that the circuit court had never directly addressed the question. The Second Circuit also outlines a seven-factor test for courts to assess the propriety of third-party releases, expressing hope that this will “guide future courts” and dispel “ambiguity” on the issue.
In reversing the district court ruling vacating Purdue’s plan confirmation order and third-party releases of the Sackler family, the Second Circuit
affirms the bankruptcy court’s order confirming Purdue’s plan and remands the case to the district court for further proceedings consistent with the opinion.
Judge Eunice Lee wrote today’s opinion for a three-judge panel that also included Judge Jon Newman and Judge Richard Wesley. Judge Lee outlines the two primary questions posed on appeal: “whether the bankruptcy court had the authority to approve the nonconsensual release of direct third-party claims against the Sacklers, a non-debtor, through the Plan” and “whether the text of the Bankruptcy Code, factual record, and equitable considerations support the bankruptcy court’s approval of the Plan.” The panel answers both questions in the affirmative.
Judge Wesley also filed a concurring opinion in which he “reluctantly” agrees with the majority’s conclusion that a bankruptcy court has the authority to approve a chapter 11 plan that includes nonconsensual nondebtor releases. Judge Wesley writes that the Second Circuit’s 1992 opinion in
Drexel Burnham Lambert Grp. “says so,” and as a result, “that ship has, for better or worse, sailed.”
Nevertheless, Judge Wesley voices concerns about the Bankruptcy Code’s silence on whether nonconsensual nondebtor releases are allowed and says “the question, which has divided the courts of appeals for decades, would benefit from nationwide resolution by the Supreme Court” (emphasis added).
As Purdue’s creditors have
observed, the chapter 11 proceedings have long been tied up in the confirmation appeal before the Second Circuit. Bankruptcy Judge Robert Drain
confirmed the plan on
Sept. 17, 2021, and Judge McMahon
reversed the plan confirmation order on Dec. 16, 2021, finding that the plan’s third-party releases were impermissible.
By the time the Second Circuit heard
oral arguments in the related “expedited” appeal in April 2022, the U.S. Trustee and certain Canadian creditors were the key parties attacking the confirmation order and defending Judge McMahon’s ruling. Certain parties who previously also opposed confirmation, known as “the Nine” - eight holdout states and the District of Columbia - reached a
settlement with the Sacklers in early 2022.
The plan supporters calling for the reversal of the SDNY ruling were the Purdue debtors, the official committee of unsecured creditors, the ad hoc committee of governmental and other contingent litigation claimants, the ad hoc group of individual victims, the multistate governmental entities group, the Raymond Sackler family and the Mortimer Sackler family.
Constitutional Authority / Stern v. Marshall
In today’s opinion, the Second Circuit agrees with Judge McMahon that the bankruptcy court lacked constitutional authority to grant final approval of the nondebtor releases in Purdue’s plan because creditors’ direct claims against the Sacklers “do not stem ‘from the bankruptcy itself.’” Following the Supreme Court’s 2011
Stern v. Marshall decision, the district court correctly treated the bankruptcy court’s confirmation opinion as “proposed findings of fact and conclusions of law for the district court’s
de novo review,” says the ruling.
For purposes of this appeal, the panel says Judge McMahon was also correct when she concluded that “the practical import of the
Stern issue is nonexistent.” This is because the appellants have asked the Second Circuit to review the bankruptcy court and district court’s legal conclusions, which would require “our
de novo review under any standard,” writes Judge Lee.
Nonconsensual Third-Party Releases of Direct Claims
The dispute at the heart of the plan appeal is “whether direct claims brought by creditors of Purdue against the Sacklers (for which the Debtors’ conduct is legally relevant) can be released,” the opinion explains. Ultimately, the panel concludes that the bankruptcy court had both jurisdiction and authority under the Bankruptcy Code to approve the nondebtor releases “
because the limitations on the scope of the releases are significant and no other argument bars their imposition” (emphasis added).
On the scope of the release, the opinion points out that during the confirmation trial, Judge Drain
scaled back certain language in the plan provision setting out the nondebtor release of the Sacklers, also known as the
shareholder release. Under the confirmed plan, the shareholder release would only “apply where ... a debtor’s conduct or the claims asserted against it [are] a legal cause or a legally relevant factor to the cause of action against the shareholder released party,” and the released claims directly affect the
res of the estate.
Judge Lee also observes that under the shareholder release, nondebtors would release both direct and derivative claims against the Sacklers. Direct claims are “causes of action brought to redress a direct harm to a plaintiff caused by a non-debtor third party,” while
derivative claims arise from harms done to the estate, the ruling explains. The potential claims released against the Sacklers include “fraudulent transfer, constructive fraudulent transfer, deceptive marketing, public nuisance, unfair competition, fraudulent misrepresentation, violation of state consumer protection acts, civil conspiracy, negligence, and unjust enrichment” - in other words, some are direct and some are derivative.
Today’s ruling rejects the UST’s argument that under the shareholder release, the Sacklers are effectively receiving a discharge in Purdue’s chapter 11 cases that is broader than what they could receive if they filed individual bankruptcy cases. Judge Lee writes that although the Bankruptcy Code “forbids a
discharge of a non-debtor’s claim under 11 U.S.C. § 524(e),
the releases at issue on appeal do not constitute a discharge of debt for the Sacklers because the releases neither offer umbrella protection against liability nor extinguish all claims” (emphasis added).
Statutory Jurisdiction
Broadly, the panel finds that the bankruptcy court had statutory jurisdiction to impose the nondebtor releases because it is “conceivable, indeed likely, that the resolution of the released claims would directly impact the
res” of the estate. For one thing, at least some of the third-party claims directly asserted against the Sacklers are “closely related” to derivative claims that the estate might bring against the Sacklers, the opinion reasons. The panel concludes that as a result of that substantial overlap, “the litigation of third-party direct claims against the Sacklers would likely impact the Debtor’s ability to pursue, and the likelihood of recovering on,” the estate’s own claims against the Sacklers.
The opinion also highlights the indemnity agreement between Purdue and the Sacklers. The court reasons that
the Sacklers would “have a reasonable basis to seek indemnity from the Debtors” for claims asserted against them, and “[t]hat possibility is enough to implicate the bankruptcy court’s” jurisdiction for matters “related to” the chapter 11 cases (emphasis added). Although the indemnity agreement does bar indemnification when a court determines that the Sacklers “did not act in good faith,” the Second Circuit continues, the “question of bad faith in this case is hotly disputed.” The point is that the Sacklers’ indemnity claims against Purdue might have a conceivable effect on the bankruptcy estate, triggering the bankruptcy court’s jurisdiction, writes Judge Lee.
Authority Under the Bankruptcy Code
The panel states that the “ultimate authority” for the imposition of nonconsensual releases of direct third-party claims against nondebtors is rooted in sections 105(a) and 1123(b)(6) of the Bankruptcy Code.
The opinion finds “unpersuasive” the UST’s argument that because “the Bankruptcy Code does not explicitly authorize third-party releases, they are outside of a bankruptcy court’s statutory authority” (emphasis added).
Turning first to section 105(a), the opinion says the plan supporters are incorrect to suggest that this provision alone justifies the bankruptcy court’s imposition of nonconsensual nondebtor releases. Section 105(a) gives “broad equitable power to the bankruptcy courts to carry out the provisions of the Bankruptcy Code,” Judge Lee writes, but
“at least one other provision of the Bankruptcy Code must provide the requisite statutory authority. Section 1123(b)(6) does” (emphasis added).
Section 1123 of the Bankruptcy Code sets out requirements for the contents of a chapter 11 plan, and subsection (b)(6) permits the inclusion of “any other appropriate provision” in a plan so long as it is “not inconsistent” with other sections of the Bankruptcy Code. The opinion explains that in
Energy Resources Co., the U.S. Supreme Court held that this provision, in tandem with section 105(a), gives bankruptcy courts a broad “residual authority.”
The UST got it wrong, says the opinion, when it argued that
Energy Resources does not support the nondebtor releases in Purdue’s plan. The UST had argued that the Supreme Court decision “does not permit reliance on § 1123(b)(6) because the third-party releases at issue here are ‘not specifically authorized by the Code’” and that the Supreme Court only spoke to the ability of bankruptcy courts to modify “creditor-debtor” relationships, but that these releases go beyond such relationships.
However, the panel writes, “We are not persuaded by Appellees’ arguments. First, as the Court’s language in
Energy Resources indicates,
§ 1123(b)(6) is limited only by what the Code expressly forbids, not what the Code explicitly allows” (emphasis added). Judge Lee reasons that “bankruptcy courts’ equitable powers under § 1123(b)(6) include the power ‘to release third parties from liability,’” citing opinions from the
Seventh Circuit and
Sixth Circuit.
The opinion adds, “Although our case law has never expressly cited § 1123(b)(6) to support the imposition of third-party releases,
we now explicitly agree with these Circuits and conclude that § 1123(b)(6), with §105(a), permit bankruptcy courts’ imposition of third-party releases” (emphasis added).
Moreover, “where Congress has limited the powers of the bankruptcy court, it has done so clearly,” Judge Lee remarks, and Congress never imposed such a limitation on third-party releases in the statute. As a result, says the Second Circuit, “we see no reason grounded in the text of the Bankruptcy Code to bar the inclusion of third- party releases in plans of reorganization.”
District Judge McMahon was incorrect when she declared that Second Circuit precedent had never directly addressed the question of nonconsensual third-party releases, says the opinion. The panel points out that the
Drexel Burnham opinion stated, “In bankruptcy cases, a court may enjoin a creditor from suing a third party, provided the injunction plays an important part in the debtor’s reorganization plan.” Similarly, the Second Circuit’s opinions in
Johns-Manville I and
Metromedia confirm that “such releases are neither discharges nor allowable only in the context of asbestos cases,” according to the opinion.
All in all, concludes Judge Lee,
“our precedents permit the imposition of third-party releases jointly under 11 U.S.C. § 105(a) and 11 U.S.C. § 1123(b)(6)” (emphasis added).
Second Circuit Standard
Next, the court identifies “the factors that should be considered in order for a bankruptcy court to approve of nonconsensual third-party releases of direct claims against a non-debtor and to include them in a plan,” setting out the following seven-factor test:
- 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.”
- Whether claims against the debtor and nondebtor are factually and legally intertwined, including whether the debtors and the released parties “share common defenses, insurance coverage, or levels of culpability.”
- Whether the scope of the releases is appropriate. The opinion adds, “In our view, a release is proper in scope” when its breadth is “necessary to the Plan.”
- Whether the releases are essential to the reorganization. In other words, “it must be the case that, without the releases, ‘there is little likelihood of [a plan’s] success.’”
- Whether the nondebtor contributed substantial assets to the reorganization.
- Whether the affected class of creditors “overwhelmingly” voted in support of the plan containing the releases. Referencing the voting requirements for plan confirmation in asbestos cases, the opinion notes that such plans require approval by a minimum of 75% of voting creditors. “However, we consider that threshold to be the bare minimum, and instead express approval for requiring overwhelming approval of the plan” (emphasis added).
- Whether the plan provides for the fair payment of enjoined claims. Judge Lee adds, “While the full payment of the enjoined claims would of course tend to favor the approval of a plan containing such releases, we are concerned with the fairness of the payment, as opposed to the final amount of payment.”
The panel states that bankruptcy courts must consider each of the seven factors, but they are not necessarily sufficient, and “there may even be cases in which all factors are present, but the inclusion of third-party releases in a plan of reorganization should not be approved.” Any nondebtor release must be weighed against the “backdrop of equity” and in light of the “potential for abuse.” Further, the bankruptcy court must support each factor with specific and detailed findings.
The opinion concludes that
under this new standard, Judge Drain correctly confirmed Purdue’s plan. The ruling reviews Judge Drain’s factual findings in detail, highlighting the over 95% acceptance rate by voting personal injury creditors and the “additional concessions” made by the Sacklers in the settlement terms that “contribute to the Plan’s equity.” These include the Sackler’s agreement to governance requirements, abatement trusts, the public document archive and the Sackers’ divestment from the opioid business worldwide.
In the face of the UST’s allegations that the Sacklers engaged in abusive conduct and used the chapter 11 process to their advantage, the Second Circuit responds that the bankruptcy court carefully considered the equities of the plan before approving it. The panel also remarks that
“to the extent that there is a fear that this opinion could be read as a blueprint for how individuals can obtain third-party releases in the face of a tsunami of litigation, we caution that the key fact regarding the indemnity agreements” between Purdue and the Sacklers
“is that they were entered into by the end of 2004 - well before the contemplation of bankruptcy” (emphasis added). The court says it “would be far less persuaded” by indemnity agreements inked in contemplation of a third-party release in bankruptcy.
Although the Second Circuit devotes most of today’s opinion to the nonconsensual third-party release in Purdue’s plan, the court also dismisses certain Canadian municipalities’ and First Nations’ appeal of the confirmation order based on an asserted Foreign Sovereign Immunity Act claim.