Reversing the district court, the Second Circuit reinstated the bankruptcy court’s confirmation of the chapter 11 plan of Purdue Pharma LP and its inclusion of nonconsensual releases of creditors’ direct claims against nondebtors.
In the majority’s 74-page opinion, Circuit Judge Eunice C. Lee found statutory authority for nondebtor, third-party releases in Sections 105(a) and 1123(b)(6) of the Bankruptcy Code and in “this Circuit’s caselaw stating that a bankruptcy court has authority to impose such releases.”
Circuit Judge Richard C. Wesley wrote a 14-page concurrence that reads like a dissent and urges the Supreme Court to grant certiorari to resolve the split of circuits. Judge Wesley concurred in the judgment because he saw the issue as having been resolved in In re Drexel Burnham Lambert Grp., Inc., 960 F.2d 285, 293 (2d Cir. 1992), Second Circuit authority that “has not been overruled either by the Supreme Court or by this Court sitting en banc.”
The third judge on the panel was Circuit Judge Jon O. Newman. Having served 44 years on the appeals court, he is the most senior judge on the Second Circuit.
The Opioid Claims, the Chapter 11 Case, and Reversal in District Court
Judge Lee devoted 30 pages of her opinion to laying out the facts, the deluge of opioid claims against Purdue and the controlling Sackler family, the chapter 11 case, the confirmation of the plan by now-retired Bankruptcy Judge Robert D. Drain and the reversal of confirmation by District Judge Colleen McMahon of Manhattan.
Foretelling the result, Judge Lee pointed out early in her opinion that the Sacklers were contributing $5.5 billion to $6 billion in return for receiving releases.
To deal with tens of thousands of lawsuits, the company filed a chapter 11 petition in September 2019, but the Sacklers did not file, nor did any company officers or directors. One month after filing, the bankruptcy court imposed an injunction halting all lawsuits against debtors and nondebtors alike.
After bankruptcy, the company resolved a criminal complaint by entering into a plea agreement that called for the company to pay $2 billion, which would come ahead of all creditor claims. However, the agreement would allow the company to pay most of the $2 billion into a trust for the benefit of claimants.
Originally, Purdue’s plan had a $4.325 billion contribution to be made by the Sacklers over nine years. In return, the individuals were to receive releases that Judge Lee characterized as “extremely broad.” With 95% in favor, she said that creditors “overwhelmingly” approved the plan.
During the course of the confirmation hearing, Bankruptcy Judge Drain required the debtors to narrow the scope of the third-party releases by providing that the debtor’s conduct must be the legal cause or a relevant factor in the claims against released individuals.
As revised, Judge Drain confirmed the plan in September 2021 and delivered a lengthy, detailed opinion finding facts and stating the law as he saw it. He noted that while most circuits permit nondebtor releases, the Fifth, Ninth and Tenth Circuits don’t.
Bankruptcy Judge Drain said the plan was the only reasonably conceivable means for resolving the case and satisfied the seven requirements demanded by In re Iridium Operating LLC, 478 F.3d 452, 464–66 (2d Cir. 2007). As authority for the nonconsensual releases, he found statutory power in Sections 105(a) and 1123(b)(6) and caselaw justification in In re Metromedia Fiber Network, Inc., 416 F.3d 136 (2d Cir. 2005), and other Second Circuit authority.
The U.S. Trustee and several states appealed. District Judge McMahon set aside confirmation by reversing in December 2021. In re Purdue Pharma, L.P., 635 14 B.R. 26 (S.D.N.Y. 2021). She found no statutory authority for the third-party releases. According to Judge Lee, the district judge “ejected the argument that the bankruptcy court possessed residual equitable authority to impose the Releases.” To read ABI’s report on the district court reversal, click here.
The Appeal to the Circuit
The company, the official creditors’ committee, the Sacklers and others appealed. The appeals court heard oral argument on April 29, 2022.
While the appeal was pending, nine states dropped their opposition to the plan when the Sacklers agreed to contribute an additional $1.175 billion to $1.675 billion, raising their total payments to as much as $6 billion.
The U.S. Trustee was the remaining appellee, along with Canadian municipalities and indigenous tribes from Canada.
Addressing the merits, Judge Lee agreed with District Judge McMahon on one point: The bankruptcy court lacked constitutional power to enter a final judgment containing the third-party releases because they are the types of claims proscribed in Stern v. Marshall. In other words, the bankruptcy court could only issue proposed findings and conclusions for entry by the district court.
Judge Lee went on to say:
[W]e agree with the district court that the practical import of the Stern issue is nonexistent given that only conclusions of law are at issue here, requiring our de novo review under any standard.
[Note: This writer respectfully disagrees. It’s not nothing. If the bankruptcy court may only enter proposed findings and conclusions in similar circumstances, a chapter 11 plan may not be confirmed and consummated until the equivalent of an appeal has been completed in district court.]
Question One
Judge Lee tackled the first of two pivotal questions: “[W]hether the bankruptcy court had the authority to approve the nonconsensual release of direct third-party claims against the Sacklers, a non-debtor.”
Judge Lee divided the releases into two categories: direct claims and derivative claims. Citing Marshall v. Picard (In re Bernard L. Madoff Inv. Secs. LLC), 740 F.3d 81, 89 n.9 (2d Cir. 2014), she said it was “well settled” that the bankruptcy court may release derivative claims, which are those that arise from harm to the estate.
On the other hand, Judge Lee defined “direct claims [as] causes of action brought to redress a direct harm to a plaintiff caused by a non-debtor third party.” Citing MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89, 91 (2d Cir. 1988), she said that a release of those claims would not be a discharge prohibited by Section 524(e), “because the releases neither offer umbrella protection against liability nor extinguish all claims.”
Next, Judge Lee agreed “with both the bankruptcy court and the district court that the bankruptcy court had statutory jurisdiction to impose the Releases because it is conceivable, indeed likely, that the resolution of the released claims would directly impact [the estate].”
Statutory Authority
Judge Lee said that the bankruptcy court “correctly grounded its authority for approving the Releases in §§ 105(a) and 1123(b)(6).” Section 105(a) allows a bankruptcy court to issue “any order” that is “necessary or appropriate to carry out the provisions of” the Bankruptcy Code.
Section 1123(b)(6) permits a chapter 11 plan to “include any other appropriate provision not inconsistent with the applicable provisions of this title.”
Judge Lee rejected the debtor’s contention that Section 105(a) alone was up to the task. However, the combination of Section 105(a) with Section 1123(b)(6) made the magic elixir. She said that “§ 1123(b)(6) is limited only by what the Code expressly forbids, not what the Code explicitly allows.” She cited the Seventh Circuit for having “convincingly” held that the section includes the power to release third parties.
If there were any doubt before, Judge Lee said, “we now explicitly agree with [the Sixth and Seventh Circuits] and conclude that § 1123(b)(6), with § 105(a), permit bankruptcy courts’ imposition of third-party releases.”
Second Circuit Caselaw
Having found statutory power, Judge Lee said that “this Court’s precedents permit the imposition of nonconsensual third-party releases.” She said that Manville and Metromedia “further confirm that such releases are neither discharges nor allowable only in the context of asbestos cases.”
“More importantly,” Judge Lee said, “this Court’s opinion in Metromedia flatly rejects a restrictive interpretation of the Bankruptcy Code by stating that third-party releases can be valid outside of the asbestos context.” She added, though, that “Metromedia nevertheless rests upon the premise that such releases may be permitted so long as bankruptcy courts make sufficient factual findings and satisfy certain equitable considerations.”
Having found jurisdiction along with statutory and caselaw authority, Judge Lee analyzed the bankruptcy court’s findings of fact and concluded that they satisfied the seven-part test imposed by Metromedia. Among other factors, the releases were necessary; the nondebtors made substantial contributions, and the affected creditors voted “overwhelmingly” in favor of the plan. She pointed to Section 524(g)(2)(B)(ii)(IV)(bb) for the concept that a 75% vote is the minimum.
Before ending her opinion, Judge Lee rejected the U.S. Trustee’s argument that due process required that creditors be allowed to opt out.
Judge Lee reversed the district court, affirmed the bankruptcy court’s approval of the plan and remanded for proceedings consistent with the opinion.
The Concurrence by Judge Wesley
Judge Wesley concurred in the judgment, because he read Drexel to mean that bankruptcy courts “have the power to release direct or particularized claims asserted by third parties against nondebtors without the third parties’ consent.”
Because Drexel had not been overruled by the Supreme Court or the Second Circuit sitting en banc, Judge Wesley said he “reluctantly” concurred. He said that neither Drexel nor Metromedia “tracks that power back to any provision of the Bankruptcy Code.” Likewise, he saw nothing in Sections 105(a) or 1123(b)(6) about nondebtor releases. Indeed, he said that the Bankruptcy Code “is silent on the matter.”
To buttress his views, Judge Wesley noted that claims for fraud cannot be discharged in bankruptcy but that the third-party releases had no carveouts for fraud. In other words, the releases, he said, were “broader than that which Congress decided was wise to make available to a debtor in bankruptcy.”
Further, Judge Wesley said that creditors with direct claims receive nothing extra for those claims. Their recovery, he said, is identical to the recovery by a similar creditor with no direct claims against third parties.
“At bottom,” Judge Wesley said, “if Congress intended so extraordinary a grant of authority, it should say so,” like it did in 1994 when amending the Code to allow nondebtor releases in asbestos cases.
Given that nondebtor releases are “an extraordinarily powerful tool,” Judge Wesley said that the question “would benefit from nationwide resolution by the Supreme Court” of “a weighty issue that, for too long, has split the courts of appeals.”
Reversing the district court, the Second Circuit reinstated the bankruptcy court’s confirmation of the chapter 11 plan of Purdue Pharma LP and its inclusion of nonconsensual releases of creditors’ direct claims against nondebtors.
In the majority’s 74-page opinion, Circuit Judge Eunice C. Lee found statutory authority for nondebtor, third-party releases in Sections 105(a) and 1123(b)(6) of the Bankruptcy Code and in “this Circuit’s caselaw stating that a bankruptcy court has authority to impose such releases.”
Circuit Judge Richard C. Wesley wrote a 14-page concurrence that reads like a dissent and urges the Supreme Court to grant certiorari to resolve the split of circuits. Judge Wesley concurred in the judgment because he saw the issue as having been resolved in In re Drexel Burnham Lambert Grp., Inc., 960 F.2d 285, 293 (2d Cir. 1992), Second Circuit authority that “has not been overruled either by the Supreme Court or by this Court sitting en banc.”
The third judge on the panel was Circuit Judge Jon O. Newman. Having served 44 years on the appeals court, he is the most senior judge on the Second Circuit.