On top of crippling opioid liability, drug-producer and distributor Mallinckrodt was saddled with securities class actions and lawsuits by governmental units regarding a different drug called Acthar. The chapter 11 petition filed in October 2020 was the only hope for avoiding slow corporate death and liquidation from insufferable litigation costing $1 million a week.
Before and after filing, the debtor hashed out settlements and a chapter 11 plan that garnered approval from every fiduciary, almost every organized creditor group and 88% of voting creditors. The plan has $1.725 billion in cash, new secured notes, warrants and other consideration parceled out among the creditor classes.
Of course, there were dissenters, including the U.S. Trustee, the Securities and Exchange Commission and classes deemed to reject the plan. With a minor modification of exculpations that were overly broad, Bankruptcy Judge John T. Dorsey of Delaware confirmed the plan in a 98-page opinion on February 3.
The confirmed plan had nondebtor, third-party releases. However, the alleged shortcomings in Mallinckrodt’s plan did not rise to the level that recently resulted in reversals of confirmation in New York and Virginia. See In re Purdue Pharma LP, 21-07532, 2021 BL 482465, 2021 WL 5979108, 2022 US Dist Lexis 8160 (S.D.N.Y. Dec. 16, 2021); and Patterson v. Mahwah Bergen Retail Group Inc., 21-167, 2022 BL 13068, 2022 US Dist Lexis 7431 (E.D. Va. Jan. 13, 2022). To read ABI’s reports, click here and here.
Although some may disagree, Mallinckrodt’s plan would not have been offensive to the district judge in Purdue, because it did not release creditors’ nonderivative, direct claims against nondebtors. Although subject more to doubt, Mallinckrodt’s plan might not have offended the district judge in Patterson, because the creditor groups giving nondebtor releases negotiated the plan and are receiving substantial recoveries.
However, the district judge in Patterson might believe that Judge Dorsey erred in ruling that the bankruptcy court had constitutional power to issue releases in favor of third parties.
Mallinckrodt’s plan is notable in several respects, according to Prof. Bruce A. Markell. He told ABI:
The opinion accomplishes everything I would want, but very little I would grant. It tackles all the current hot-buttons of mass tort reorganization — third party releases, consents obtained through the use of opt-outs, and validation of gifting that freezes out identifiable classes to the benefit of those favored by the donor — and resolves each of them in favor of the debtor’s reorganization. Unfortunately, I disagree that the reorganization achieved is one anticipated or authorized by the Code. The result may be the best one possible on utilitarian grounds, but those grounds are not written into the Code nor have they been embraced or enacted by Congress.
Prof. Markell is the Professor of Bankruptcy Law and Practice at the Northwestern Univ. Pritzker School of Law.
Chapter 11 practitioners should set aside several hours to read the opinion in full text.
Nondebtor Releases
The plan releases claims against nondebtors, such as officers and directors. Unlike Millennium Lab Holdings II, LLC, 945 F.3d 126 (3d Cir. 2019), where shareholder defendants paid $325 million for their releases, the U.S. Trustee opposed the releases because the released third parties are paying nothing for theirs. For ABI’s report on Millennium, click here.
Judge Dorsey noted that the third-party releases were negotiated, to a large extent, with fiduciaries for claimants giving the releases. Were there no releases, he said that the debtor would be dragged back into litigation in view of indemnification rights. If there were continued litigation and no settlements and releases, Judge Dorsey concluded that claimants would have lower recoveries because the debtor would end up in liquidation.
With regard to releases that might be nonconsensual for some classes, Judge Dorsey said it was “exactly the type of extraordinary case the Third Circuit alluded to in Continental, where nonconsensual releases might be appropriate.” For the classes that negotiate the settlements and releases, he said they were “both necessary and fair” and “overwhelmingly supported by the creditor body.”
To the argument that the bankruptcy court lacked statutory or constitutional power, “the fact is,” Judge Dorsey said, “that only one single creditor out of hundreds of thousands actually objected to these releases. To apply a blanket prohibition on non-consensual releases in this case would simply not make sense.”
Opting Out
The Securities and Exchange Commission and the U.S. Trustee objected to releases on the part of shareholders, arguing that the releases were impermissibly nonconsensual because the class was deemed to reject the plan. They contended that the ability to opt out did not make the releases consensual and subjected the releases to the Continental test.
Despite the debtor’s extensive trolling for opt-outs, Judge Dorsey said there had only been 2,200. Conceding that not all courts agree, he decided “that they are appropriate.” He noted that the plan was “supported by every estate fiduciary, almost every organized creditor group, and 88% of voting creditors.”
Unfair Discrimination, Horizontal Gifting
The so-called waterfall proffered by the debtor indicated that some subgroups of unsecured creditors would receive no recovery if distributions were made solely in accordance with bankruptcy priorities. Significantly, unsecured noteholders held guarantees from all of the myriad debtor entities. Other unsecured creditor groups might have recourse against only one debtor entity with little value.
The waterfall revealed that unsecured noteholders would be entitled to $1.4 billion. Under the same scenario, other general unsecured creditors receive $22.5 million, but only three of the seven subclasses would receive anything at all.
“To avoid litigation with constituents in the other unsecured classes and facilitate settlements,” Judge Dorsey said that the noteholders “agreed to reallocate or ‘gift’ $228.5 million of their Entitled Recovery” to other classes of unsecured creditors.
As a result, Judge Dorsey said one subclass of unsecured creditors with $41 million in claims would have its recovery rise from 1% to 100%. Another subclass would go from nothing to 4%.
To analyze the propriety of gifting in the case before him, Judge Dorsey adopted the test proffered by Prof. Markell and decided there was a rebuttable presumption of gifting that would amount to unfair discrimination prohibited by Section 1129(b)(1).
On the question of unfair discrimination, Judge Dorsey found none, because the debtor had rebutted the presumption. He cited Third Circuit authority and said it is “irrelevant” when one “out of the money unsecured creditor class is doing better” than another out-of-the-money creditor.
Observations
Prof. Markell is the leading scholarly authority among those who believe that gifting is not permitted by the Bankruptcy Code. His commentaries are to be found in Bruce A. Markell, “A New Perspective on Unfair Discrimination in Chapter 11,” 72 Am. Bankr. L.J. 227 (1998); and Bruce A. Markell, “The Clock Strikes Thirteen: The Blight of Horizontal Gifting,” 38 Bankr. L. Ltr. 12 (Dec. 2018). To read his more recent discussion, click here.
In his later work on horizontal gifting, like that afoot in Mallinckrodt’s plan, Prof. Markell contends there is no gift. Rather, he says, the gift-giver is obtaining releases and injunctions and a shorter path to confirmation. He said, “Creditors ought not to be able to change results Congress picked by bribes to out-of-the-money classes.”
The opinion is In re Mallinckrodt PLC, 20-12522 (Bankr. D. Del. Feb. 3, 2022).