top of page

BANKRUPTCY CANNOT RESOLVE THIRD-PARTY CLAIMS WITHOUT CONSENT

Writer's picture: Paul Peter Nicolai Paul Peter Nicolai

The Supreme Court has barred the issuance of nonconsensual third-party releases in Chapter 11 bankruptcy plans. The Court said that the bankruptcy code does not authorize a release and injunction that, as part of a plan of reorganization under Chapter 11, effectively seeks to discharge claims against a non-debtor without the consent of affected claimants.

 

Purdue was a manufacturer of OxyContin. Purdue was owned and controlled by the Sacklers. Sales of OxyContin soared as it became the most prescribed brand-name narcotic medication. Purdue ultimately became a defendant in thousands of lawsuits claiming injuries from deceptive marking practices. During this time, the Sacklers received approximately $11 billion in distributions, about $4.6 billion of which paid taxes.

 

Purdue filed for relief under Chapter 11 of the United States Bankruptcy Code. It proposed a plan that included payment by the Sacklers of $4.325 billion in return for releasing all claims of the debtors and from third parties. Specifically, the Sacklers wanted to end the growing number of lawsuits brought against them by claimants with damages resulting from the company’s products. The proposed plan would have provided recoveries for the individuals harmed by the company’s products ranging from $3,500 to $48,000, depending upon the severity of the injuries.

 

The United States Trustee opposed the plan, as did some government entities. The bankruptcy court overruled these objections and confirmed the plan. On appeal, the district court vacated confirmation. It held that the bankruptcy code did not allow the release of third-party claims without the claimants’ consent. The plan proponents (i) appealed the decision and (ii) increased the proposed Sackler payment in exchange for withdrawing specific objections. The U.S. Trustee and others continued their opposition to the plan.

 

The Second Circuit reversed the district court and approved the plan modified by the additional proposed payment. The U.S. Trustee sought a stay of confirmation, which was granted by the Supreme Court and treated as a petition for writ of certiorari to address the issue of whether the bankruptcy code authorized nonconsensual releases of third-party claims.

 

The majority focused the Purdue opinion on Section 1123(b) of the bankruptcy code, which addresses permissible components of a Chapter 11 plan. Among these provisions, the only one that could allow for third-party releases was Section 1123(b) (6), which authorizes a plan to include any other appropriate provision not inconsistent with the applicable provisions of this title. The majority first rejected the argument that paragraph 6 authorizes any provision not expressly prohibited as long as the judge deems it appropriate. The Court interpreted this catch-all paragraph in light of its surrounding context to embrace only objects similar in nature to the specific examples preceding it.

 

Finding that all the preceding provisions concern the debtor and its relationship with creditors, the Court concluded the paragraph could not be reasonably read to endow a bankruptcy court with the radically different power to discharge the debts of a non-debtor without the consent of affected non-debtor claimants. The Court noted that the text could have permitted anything not expressly prohibited, but it does not.

 

It next addressed the purpose of bankruptcy plans. Acknowledging that bankruptcy law addresses some collective-action problems, it rejected the argument that this would allow a bankruptcy court to resolve all such problems to extinguish claims of third parties without their consent. The Court then looked at other bankruptcy code provisions, including the discharge, that apply only to debtors and found no other code provision that would allow for third-party releases. The Court looked at the history of bankruptcy law. It concluded the history provided no support for third-party releases.

 

The Court declined to address the policy and ramifications of unwinding the plan, including the possibility that the opioid victims may have no viable path to recovery anytime soon. According to the Court, Congress is the appropriate forum to address those concerns.

 

How the decision impacts consensual third-party releases is unclear. Consensual third-party releases are presumed to be valid. Precisely, what constitutes consent is far from clear. Some courts have concluded that a creditor who votes in favor of a plan has consented to a release. Other courts have held that even if a creditor does not vote in favor of the plan but fails to opt out of the release affirmatively, they may be deemed to have consented to such release. The area of consensual releases is likely to continue to divide courts.

 

The Purdue decision also did not address exculpation provisions often included in bankruptcy plans. These provisions are generally more limited and protect professionals, committee members, and employees involved in the bankruptcy case. While exculpation provisions may be distinguishable on some bases, the Purdue rationale may call those provisions into question and result in future litigation.

 

The Supreme Court was clear that the decision did not address plans that were confirmed long ago and included nonconsensual third-party releases.

 

The decision will likely influence motions or complaints seeking to extend the automatic stay to third parties. Chapter 11 debtors sometimes seek to extend the automatic stay to their officers and directors to allow them to focus on reorganizing the company. Recently, the United States Bankruptcy Court for the Northern District of Illinois granted a motion to enjoin creditors from pursuing a debtor’s officers but noted that such an injunction could no longer be premised on the likelihood of a third-party release under a confirmed plan.

 

Finally, the Purdue decision reasoning is likely to influence courts as they make rulings under other provisions of the Bankruptcy Code that include broad language.

Comments


bottom of page