June 09, 2023
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Non-consensual third-party releases are provisions in reorganization plans that release non-debtor parties from liability to other non-debtor parties without the consent of all potential claimholders. These releases are frequently included in chapter 11 plans of reorganization. Most circuit courts allow these releases under certain circumstances; however, there is a split among circuit courts as to whether such non-consensual third-party releases are permitted by the Bankruptcy Code.
On May 30, 2023, in a highly anticipated ruling, the United States Court of Appeals for the Second Circuit held that bankruptcy courts have the authority to approve plans with non-consensual releases of direct third-party claims against a non-debtor. The Second Circuit articulated seven factors courts should consider before imposing non-consensual third-party releases and, in overruling the Southern District of New York, found that the bankruptcy court properly imposed non-consensual third-party releases when it confirmed Purdue’s chapter 11 plan.
The Sackler family owned and operated Purdue Pharma (Purdue) for decades. In the 1990s, Purdue released the drug OxyContin. Purdue aggressively promoted the opioid, minimizing its addiction concerns. Consequently, OxyContin usage proliferated across the country. OxyContin was one of the major causes of the opioid epidemic. The aftermath of the opioid epidemic resulted in mass civil claims against Purdue and the Sacklers.
In September 2019, Purdue filed for chapter 11 bankruptcy. The Sacklers did not file for bankruptcy. During settlement negotiations, the Sacklers agreed to contribute approximately $4 billion to the debtors’ bankruptcy estate in exchange for all civil claims against them being released.
On September 17, 2021, U.S. Bankruptcy Judge Robert D. Drain of the Southern District of New York approved the plan but limited the releases such that they 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.”
The U.S. District Court for the Southern District of New York, however, reversed, holding that the Bankruptcy Code does not permit bankruptcy courts broad authority to impose non-consensual third-party releases in reorganization plans. The District Court also disagreed with the bankruptcy court that Second Circuit precedent permits non-consensual third-party releases. During the pendency of this Appeal, the Sacklers agreed to increase their bankruptcy contribution to $5.5 billion in a revised settlement agreement.
The Second Circuit held that bankruptcy courts have the authority to impose non-consensual releases of third-party claims in limited circumstances, thereby reversing the district court’s holding. The Second Circuit articulated seven factors courts should consider before imposing such releases: (1) whether there is an identity of interests between the debtors and related third parties; (2) whether claims against the debtor and third party are intertwined; (3) the scope of the releases; (4) whether the releases are essential to the reorganization’s success; (5) the third party’s contribution of “substantial assets” to the reorganization; (6) whether the impacted claimholder class(es) “overwhelmingly” support the releases; and (7) whether the plan provides fair payment of the enjoined claims.
In applying these factors to the Sacklers’ release, the Second Circuit concluded that the bankruptcy court’s approval of the release was appropriate. First, because the Sacklers were directors and officers of Purdue, a closely held corporation, there was a sufficient identity of interests between the two parties. Second, because the bankruptcy court narrowed the release to only direct claims against the Sacklers, the claims between the parties were “sufficiently intertwined.” Considering the third and fourth factors jointly, the court found that the releases were necessary to the reorganization and proper in scope, because they were essential to ensure that the res of the estate was settled and not entirely depleted. The court clarified that if the only reason for including a release is the third party’s contribution to the bankruptcy, then the release is not essential to the plan. Fifth, focusing on the impact of the Sacklers’ financial contribution, the Second Circuit concluded that the $5.5 billion pledged by the Sacklers, potentially the largest sum ever contributed to a bankruptcy, was a substantial contribution. Sixth, the personal injury classes “overwhelmingly” approved the plan by over ninety-five percent. The court highlighted that the plan’s main challenger in this appeal was the U.S. Trustee, not potential claimholders. Finally, although the estimated value of potential claims against the Sacklers surpassed their net worth, the plan provided fair payment of claims—which far exceeded the total funds available, as well as the Sackler’s personal wealth.
Although the Bankruptcy Code does not expressly permit third-party releases, the Second Circuit derived statutory authority to impose such releases from §§105(a) and 1123(b)(6) of the Bankruptcy Code. Specifically, the Circuit Court explained that these sections jointly grant bankruptcy courts “residual authority” to modify creditor-debtor relationships by including other provisions in a plan not inconsistent with the Bankruptcy Code.[1] The Court further reasoned that because the Bankruptcy Code does not explicitly forbid third-party releases, such releases are not inconsistent with the Bankruptcy Code. Therefore, bankruptcy courts have implied equitable authority to impose such releases in chapter 11 plans.
The Circuit Court also found that § 524(e) is not a statutory impediment to third-party releases. Additionally, the fact that § 524(g) is silent regarding non-consensual third-party releases outside of the asbestos context does not alter bankruptcy courts’ “pre-existing authority” to impose such releases.
Relying on a trio of cases,[2] the Second Circuit also disagreed with the District Court’s determination that its precedent does not support the imposition of non-consensual third-party releases. Further, the Second Circuit confirmed that these releases are not impermissible discharges and can be valid outside of asbestos litigation.
Finally, the Circuit Court was clear that its reasoning did not consider whether the Sacklers were worthy of being released from liability and warned that its opinion should not be utilized as a loophole for individuals seeking to avoid mass-tort liability.
[1] United States v. Energy Resources Co., Inc., 495 U.S. 545, 545, 549 (1990) (permitting approval of reorganization plans “designating tax payments as either trust or nontrust fund” without express authorization from the Bankruptcy Code).
[2] MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89 (2d Cir. 1988) (“Manville I”) (ruling that injunctions enjoining third-party claims are not de facto discharges); In re Drexel Burnham Lambert Grp., Inc., 960 F.2d 285, 293 (2d Cir. 1992) (holding that bankruptcy courts may enjoin a creditor from suing third parties if the injunction plays an important role in the reorganization plan); Deutsche Bank AG v. Metromedia Fiber Network, Inc. (“In re Metromedia Fiber Network, Inc.”), 416 F.3d 136 (2d Cir. 2005) (holding that third-party releases can be valid outside of asbestos litigation).
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