Non-consensual releases of creditors’ direct claims against non-debtors are not permitted by the Bankruptcy Code, according to District Judge Colleen McMahon of Manhattan, who vacated the bankruptcy court’s confirmation of the controversial Purdue Pharma LP chapter 11 plan.
Had the reorganization plan been upheld (or if it is upheld after appeal to the Second Circuit), the controlling Sackler family’s $4.325 billion contribution to the reorganization plan would have absolved them from all liability stemming from the opioid crisis, even if creditors with direct claims did not consent.
Judge McMahon’s 142-page decision on December 16 is perhaps the most outstanding and remarkable bankruptcy opinion of the decade. Unless reversed on appeal, she will have barred debtors from confirming chapter 11 plans in the Second Circuit with non-consensual releases of creditors’ direct claims against non-debtor third parties.
Prof. Ralph Brubaker agrees. He told ABI:
This is one of the most consequential decisions for the chapter 11 system that’s ever been handed down. Judge McMahon’s decision goes even further than the previous decisions of the Fifth, Ninth, and Tenth Circuits prohibiting nonconsensual non-debtor releases. Judge McMahon has forcefully declared that bankruptcy judges have no inherent common-law discharge power. That power resides exclusively with Congress, and outside of asbestos cases, nothing in the Bankruptcy Code authorizes bankruptcy judges to discharge the obligations of a nondebtor.”
Prof. Brubaker is the James H.M. Sprayregen Professor of Law at the University of Illinois College of Law.
The Decision Is Limited
Contrary to what may have been reported in the press, Judge McMahon did not prohibit all non-debtor releases, nor did she bar members of the Sackler family from obtaining releases from perhaps the majority of opioid claims.
Judge McMahon’s opinion is narrow. She only barred non-consensual releases where creditors have direct claims against the Sacklers that are not derivative of claims that the company has against family members.
Judge McMahon’s opinion is consistent with the Second Circuit’s approval of more limited releases given to non-debtors in the liquidation of the Bernard Madoff Ponzi scheme. There, the Manhattan-based appeals court ratified non-consensual releases given to non-debtor defendants who knew that Bernard Madoff was conducting a Ponzi scheme and who made settlements with the trustee on the understanding that they could not be sued by Madoff’s defrauded customers. The releases only applied when defrauded customers were suing on the same claims held by the Madoff trustee.
U.S. Attorney General Merrick B. Garland applauded the opinion. Immediately after it came down, he issued a statement saying that the “bankruptcy court did not have the authority to deprive victims of the opioid crisis of their right to sue the Sackler family.” The statement is an overbroad characterization of the opinion, but it signals that the government is on the side of limiting third-party releases in bankruptcy cases if the case eventually goes to the Supreme Court.
The opinion has ominous implications for other mass-tort bankruptcies, like the Boy Scouts’ chapter 11 case in Delaware. Judge McMahon’s opinion is not binding on the bankruptcy judge in Delaware. However, the plan proposed by the Boy Scouts would bar thousands of claims by allegedly abused men who have direct claims against scout leaders and organizations not in bankruptcy. It remains to be seen if the Delaware courts follows the Purdue decision from New York.
The Executive Summary
Judge McMahon in substance wrote an executive summary about her legal conclusions on pages 6 and 7 of her typescript opinion. She said that the bankruptcy court had subject matter jurisdiction to enter non-consensual releases, even though the bankruptcy court “may have lacked constitutional authority” to give final approval.
The “great unsettled question,” Judge McMahon said, is whether “any court . . . is statutorily authorized to grant such releases.” The circuits are split, but the Second Circuit “has not yet analyzed the issue,” despite having “identified the question” in 2005.
“This will no longer do,” Judge McMahon said. “Either statutory authority exists or it does not. . . . Moreover, the lower courts are desperately in need of an answer.”
In her summary, Judge McMahon summed up her holding:
[T]he Bankruptcy Code does not authorize such non-consensual non-debtor releases; not in its express text (which is conceded); not in its silence (which is disputed); and not in any section or sections of the Bankruptcy Code that, read singly or together, purport to confer generalized or “residual” powers on a court sitting in bankruptcy.
Judge McMahon found it unnecessary to reach constitutional questions. Likewise, she did not decide whether the settlement with the Sacklers was permissible if the Second Circuit were to decide that she was wrong about releases.
“This is a real ‘the emperor has no clothes’ moment for the chapter 11 system,” Prof. Brubaker told ABI. He added:
The legal legitimacy of nonconsensual non-debtor releases has always been dubious, at best. The parties, though, have engaged bankruptcy and appellate judges in an ultra-high-stakes game of chicken, daring them to blow up complex deals they have spent years and many millions (and in the Purdue case, hundreds of millions) of dollars negotiating. Judge McMahon is pressing the Second Circuit (and perhaps ultimately the Supreme Court) to put an end to that practice by definitively resolving the legal permissibility of nonconsensual non-debtor releases, once and for all.
The Facts
In minute detail, Judge McMahon laid out the facts and procedural history in the first 70 pages of her opinion, allowing the Second Circuit to focus on the law in the inevitable next appeal.
Purdue is a privately-held company owned by members of the Sackler family and controlled by them until not long before bankruptcy. Between 1996 and 2019, Purdue had revenue of $34 billion, with 91% emanating from the company’s opioid called OxyContin.
Judge McMahon explained how Purdue pled guilty to one felony count in 2007 for falsely marketing the opioid. Four company officers pled guilty to misdemeanor charges of misbranding. The company paid $600 million in fines.
After the plea, Judge McMahon said that the company’s profits “were driven almost exclusively” by aggressively marketing the opioid.
By 2014, lawsuits were mounting, and Sackler family members were being named as defendants. Discovery led to allegations that some of the Sacklers set sales targets for the opioid that were higher than those recommended by company executives.
Citing the bankruptcy judge’s findings, Judge McMahon said that the Sacklers “distributed significant sums of Purdue money to themselves” from 2008 to 2016, when they were “aware of the opioid crisis and the litigation risk.”
The distributions from 2008 to 2016 were a “sharp departure” from the practice in 1996 to 2007. In the prior years, the distributions to the family amounted to about 9% of company revenue, enough to cover taxes. In the later years, the distributions were an average of 53% of revenue, Judge McMahon said.
The distributions in the later years aggregated about $10.4 billion. Of the total, some $4.6 billion paid pass-through taxes. The family’s own expert said that the withdrawals substantially reduced the company’s “solvency cushion.”
Judge McMahon cited the bankruptcy judge for saying that the distributions would allow the company to assert more than $11 billion in avoidable transfers.
Facing a “veritable tsunami of litigation,” the company filed a chapter 11 petition in September 2019. Immediately, the bankruptcy court approved a temporary injunction barring suits against the Sackler family, their trusts and other officers, directors or employees.
The injunction stopped more than 2,900 suits against the company and 400 against the Sacklers. Upheld in district court, the injunction was extended 18 times, until plan confirmation this year.
In the chapter 11 case, 614,000 creditors filed claims asserting damages for more than the world’s domestic product, Judge McMahon said. Nonetheless, the so-called bar date occurred before potential creditors with direct claims against the Sacklers were to learn that that the plan would extinguish their claims.
The company took another plea in 2020 while in bankruptcy, conceding extensive violations of the 2007 plea agreement. Judge McMahon said the violations “began almost from the time the ink was dry” on the 2007 plea deal.
The Chapter 11 Plan
With the help of mediators, the Sacklers agreed to contribute $4.325 billion toward Purdue’s chapter 11 plan, on the condition that their payments over nine years would end lawsuits against the family for all time.
Demanded by the bankruptcy judge, Purdue amended its plan to provide that the non-consensual releases in favor of the Sacklers barring future litigation would apply only where the company’s conduct was “a legal cause or a legally relevant factor to the cause of action against” a family member.
Judge McMahon said that the non-consensual releases in the plan in favor of the Sacklers would cover “[a]ll present and potential claims connected with OxyContin and other opioids.” She said that the releases included “third-party claims that could not be asserted by the Debtors against” the Sacklers “but were particularized to others.”
“Chief among those claims,” Judge McMahon said, “are claims asserted by the states — both consenting states and the objecting states — arising under various unfair trade practices and consumer protection laws that make officers, directors and managers who are responsible for corporate misconduct personally liable for their actions.”
Judge McMahon characterized the plan as providing “broad releases” to members of the Sackler family, “not just of derivative, but of particularized or direct claims.”
The U.S. Trustee, eight states and others objected to confirmation. The U.S. Attorney from New York filed a statement of interest supporting objections to the breadth of the releases.
Summarizing the bankruptcy judge’s confirmation opinion in detail, Judge McMahon called it “a judicial tour de force.” The bankruptcy judge found no other reasonably conceivable means to achieve the result reached by the plan and said that failure to confirm the plan would lead to Purdue’s liquidation and no recovery for unsecured creditors, including personal injury plaintiffs.
The bankruptcy judge confirmed the plan on September 17, 2021, “with obvious reluctance,” Judge McMahon said. The plan had been approved overwhelming by creditors.
The U.S. Trustee, eight states, the District of Columbia, several cities in Canada, several Native American tribes and a number of pro se creditors filed appeals from the confirmation order. The U.S. Attorney in New York filed an amicus brief supporting the appellants.
To preclude invocation of equitable mootness, Judge McMahon accelerated the appeal and issued her decision on December 16, before the plan was due to be consummated.
Stern v. Marshall
On the merits, Judge McMahon first addressed the standard of review and the implications of Stern v. Marshall, 564 U.S. 462 (2011). She said that the bankruptcy judge “improperly elided” his authority to confirm the plan, “an indubitably core function,” with authority to dispose of claims finally where the bankruptcy court only had “related to” jurisdiction.
Judge McMahon disagreed with a recent Third Circuit opinion where the Philadelphia-based appeals court read Stern as allowing the bankruptcy court to confirm a plan with similar releases because the injunctions were “integral” to restructuring the debtor-creditor relationship. See Millennium Lab Holdings LLC, 945 F.3d 126 (3d Cir. 2019), cert. den. 140 S.Ct. 2805 (2020). To read ABI’s report on Millennium, click here.
Applying Stern, Judge McMahon said that the proper analysis requires deciding whether the releases “would necessarily be resolved in the claims allowance process — not whether the release and injunction are ‘integral to the restructuring of the debtor-creditor relationship.’” She said that the debtor “cannot manufacture constitutional authority to resolve a non-core claim by the artifice of including a release of that claim in a plan of reorganization.”
Because the nonconsensual releases were “the equivalent of a final judgment for Stern purposes,” Judge McMahon held that the bankruptcy judge did not have power to enter a final order and “should have tendered” proposed findings and conclusions of law.
Prof. Brubaker agrees that Stern does not allow the bankruptcy court to enter a final confirmation order with releases of the sort. See Ralph Brubaker, A Case Study in Federal Bankruptcy Jurisdiction: Core Jurisdiction (or Not) to Approve Non-Debtor ‘Releases’ and Permanent Injunctions in Chapter 11, 38 Bankr. L. Letter No. 2, at 7-8 (Feb. 2018). To read, click here.
N.B.: Should Judge McMahon’s analysis be adopted universally, equitable mootness will not be an issue in cases where the district judge alone can enter a final order of confirmation. To the argument that the delay resulting from district court review would be the death of chapter 11 cases, the answer is this: The district and bankruptcy judges could sit together at the confirmation hearing.
Subject Matter Jurisdiction
Objectors argued that the bankruptcy court lacked subject matter jurisdiction to underpin releases. Judge McMahon recognized that third parties’ claims against non-debtors “touches the outer limits of the Bankruptcy Court’s jurisdiction.”
In the Second Circuit, Judge McMahon said there is subject matter jurisdiction if the outcome might have “any conceivable effect” on the estate.
Judge McMahon said there was “absolutely no question” about the existence of subject matter jurisdiction under the rubric of “related to” because the releases might have a conceivable effect on the estate.
Statutory Authority for Non-Debtor Releases
Throughout, when we refer to releases, we mean non-consensual releases of creditors’ direct claims against non-debtors. Releases will not refer to derivative claims, which Judge McMahon defined as meaning claims that would make the Sacklers liable based on the company’s actions.
Releases refers to injunctions barring claims based on non-debtors’ own conduct, “predicated on their own alleged misconduct and the breach of duties owed to claimants other than Purdue,” Judge McMahon said.
Judge McMahon did not leave the reader in suspense for long. She quickly said that the Bankruptcy Code “does not confer on any court the power to approve the release of non-derivative third-party claims against non-debtors, including specifically” some of the releases in the Purdue plan.
The Primacy of Section 524(g)
Judge McMahon found only one provision in the Bankruptcy Code, Section 524(g), which authorizes injunctions barring third-party claims, and then “exclusively in cases involving . . . injuries arising from the . . . sale of asbestos.” In confirming the Johns-Manville plan years ago, she noted that the Second Circuit “did not cite to a single section of the Bankruptcy Code as authorizing the entry of the injunction.” See MacArthur Co. v. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89 (2d Cir. 1988).
After Manville, Congress adopted Section 524(g), codifying the result in Manville for asbestos cases. Judge McMahon interpreted the statute to mean that Congress retained “the task of determining whether and how to extend a rule permitting non-debtor releases . . . into other areas.”
In other words, Judge McMahon believes that Manville was not binding on her and did not compel her to approve the Purdue plan because the decision was overruled sub silentio when Congress later adopted Section 524(g).
The Split Among the Circuits
Judge McMahon surveyed the circuits, where she found “a long-standing conflict among the Circuits” and no “definitive guidance” from the Second Circuit. After Manville, she said in substance that no Second Circuit decision had actually approved non-debtor releases. She cited Madoff for the notion that Section 105(a) supplied power to enjoin derivative claims. See In re Bernard L. Madoff Inv. Securities LLC, 740 F.3d 81 (2d Cir. 2014).
Summarizing, Judge McMahon said that Second Circuit law is “unsettled, except in asbestos cases where statutory authority is clear. . . . [I]ts only clear statement is that Section 105(a), standing alone, does not confer such authority . . . outside the asbestos context.”
The other circuits are in conflict, Judge McMahon said. The Fifth, Ninth and Tenth Circuits “reject entirely the notion that a court can authorize non-debtor releases outside the asbestos context.”
In approving releases of the type, Judge McMahon said that the Third Circuit “has not identified any section of the Bankruptcy Code that authorizes such non-debtor releases.” The Fourth and Eleventh Circuit “have concluded that Section 105(a), without more, authorizes such releases.”
Judge McMahon read the Sixth and Seventh Circuits as holding that Sections 105(a) and 1123(b)(6), “read together, codify something that they call a bankruptcy court’s ‘residual authority’” to impose releases.
The Purdue bankruptcy judge found statutory authority from a combination of Sections 105(a), 1123(a)(5), (b)(6) and 1129. Judge McMahon said that those sections only confer power “to enter orders that carry out other, substantive provisions of the Bankruptcy Code.” Since the Code nowhere authorizes releases of the type, she held that none of them conferred the necessary statutory power.
Judge McMahon noted that some of the governments’ claims for civil penalties would not be dischargeable even if the individuals were to file their own bankruptcies.
The Debtor’s Other Arguments
The debtor argued that the absence of a statutory prohibition permitted the releases.
Judge McMahon said that Congress has not been silent. It “has in fact spoken” in “Sections 524(g) and (h) to preempt the field where non-debtor releases are concerned. . . . Congress in its wisdom elected to limit Code-based [releases] to asbestos litigation.”
Finally, Judge McMahon found no “residual authority.” If residual power were to exist, it would be “exercised in contravention of specific provisions of the Bankruptcy Code.” She declined “to insert a right that does not appear in the Bankruptcy Code to achieve a bankruptcy objective.”
Because “the Bankruptcy Code confers no such authority” to grant releases, Judge McMahon ruled that “the order confirming the Plan must be vacated.”
Scholarly Commentary
Prof. Brubaker identifies a path for reaching the same result without stretching a bankruptcy court’s statutory powers beyond the breaking point. In a forthcoming article in the Yale Law Journal Forum, he says that “efficient (and fair) joint settlements of both debtors’ and nondebtors’ mass tort liability will still be possible, even (and particularly) if nonconsensual nondebtor releases are prohibited.” Ralph Brubaker, Mandatory Aggregation of Mass Tort Litigation in Bankruptcy, 131 Yale L.J.F. (forthcoming 2022).
He goes on to say that the “essential architecture for facilitating powerful aggregation and corresponding settlement of tort victims’ claims against nondebtors already exists in the bankruptcy jurisdiction, removal, and venue provisions of” 28 U.S.C. § 157(b)(5). The section, he said, “provides for single-district consolidation of all creditors’ related personal injury claims against a nondebtor, in a manner similar to an MDL consolidation. . . . In fact, section 157(b)(5) consolidations would be an immensely more powerful and fairer centralization process than MDL consolidations.”
To read the forthcoming article, click here
Non-consensual releases of creditors’ direct claims against non-debtors are not permitted by the Bankruptcy Code, according to District Judge Colleen McMahon of Manhattan, who vacated the bankruptcy court’s confirmation of the controversial Purdue Pharma LP chapter 11 plan.
Had the reorganization plan been upheld (or if it is upheld after appeal to the Second Circuit), the controlling Sackler family’s $4.325 billion contribution to the reorganization plan would have absolved them from all liability stemming from the opioid crisis, even if creditors with direct claims did not consent.
Judge McMahon’s 142-page decision on December 16 is perhaps the most outstanding and remarkable bankruptcy opinion of the decade. Unless reversed on appeal, she will have barred debtors from confirming chapter 11 plans in the Second Circuit with non-consensual releases of creditors’ direct claims against non-debtor third parties.