USE OF NON-CONSENSUAL THIRD-PARTY RELEASES IN BANKRUPTCY PLANS HEADED TO THE SECOND CIRCUIT AND POSSIBLY BEYOND

The U.S. District Court for the Southern District of New York (the “District Court”) recently overturned the U.S. Bankruptcy Court for the Southern District of New York’s confirmation of drugmaker Purdue Pharma’s controversial Chapter 11 Bankruptcy Plan (the “Plan”). At issue was Purdue Pharma’s use of non-consensual releases of third parties in this case, a release of civil claims relating to Purdue Pharma’s opioid prescription business against its founders and owners, the Sackler family. While the Bankruptcy Court found the use of these non-consensual third-party releases in the best interest of the Purdue Pharma bankruptcy estate (the “Estate”) and its creditors, the District Court disagreed, finding that the Bankruptcy Code does not permit the use of non-consensual third-party releases outside of asbestos cases.

The District Court granted Purdue Pharma leave to immediately appeal the decision to the U.S. Court of Appeals for the Second Circuit (the “Second Circuit”) and that decision will almost certainly be appealed to the U.S. Supreme Court (“Supreme Court”) by the losing party. The impact of pending opioid litigation on the Plan coupled with the existing circuit split amongst various Courts of Appeals on whether the use of non-consensual third-party releases is permitted under the Bankruptcy Code make it very likely the Supreme Court will hear the case.

A non-consensual third-party release essentially releases third parties that did not file for bankruptcy from claims that could otherwise be brought against them, in exchange for the released parties’ payment into a pool of funds. In the Purdue Pharma case, the Sackler family agreed to pay $4.275 billion into a settlement pool to pay opioid-related claims in exchange for broad, non-consensual releases of direct and derivative opioid-related claims against the family members, none of whom filed for bankruptcy.

The genesis of non-consensual third-party releases can be found in Section 524(g) of the Bankruptcy Code, which allows non-consensual third-party releases “solely and exclusively in cases involving injuries arising from the manufacture and sale of asbestos.” However, while the Bankruptcy Code’s third-party release provisions apply only to asbestos cases, the Second Circuit previously held that non-consensual third-party releases can be approved in other cases in “appropriate, narrow circumstances.”[1]

While the use of non-consensual third-party releases may seem unfair at first blush, they have proven to be a powerful tool in helping chapter 11 debtors reorganize and continue to operate by providing an incentive for non-parties to voluntarily provide funds necessary to settle mass tort and fraud claims against the debtor. Absent this external funding source, many debtors would lack the assets to pay mass tort and fraud claimants while continuing to operate. Such arrangements also allow claimants to get paid without having to retain counsel and file separate (and potentially costly) lawsuits against these third parties with unknown outcomes and recoveries. According to Purdue Pharma, without the injection of external funds it would likely have to liquidate instead of reorganize in bankruptcy (through a sale to a non-Sackler entity), which would result in significantly less money available to pay claimants.

Opponents of the use of non-consensual releases of the Sackler family argue that this arrangement allows the Sackler family to avoid facing lawsuits related to the opioid crisis without having to file for bankruptcy (potentially making even more assets available for recovery), while also getting away with moving $10 billion of Purdue Pharma’s cash reserves into offshore accounts prior to Purdue Pharma’s bankruptcy filing (an allegation disputed by the Sackler family).

Ultimately, the District Court found that the Bankruptcy Code does not allow the use of non-consensual third-party releases outside of the asbestos context= and that such releases deny claimants their due process rights against non-debtors. These claimants are entitled to their “day in court” to try to obtain a judgement or settlement in excess of what would be paid through the Sackler family’s contribution the Plan.

However, the District Court itself recognized that its decision “will not be the last word on this subject, nor should it be.” The decision has already been appealed to the Second Circuit, which agreed to hear the case on an expedited basis. Yet, surprisingly, on March 9 the Bankruptcy Court, notwithstanding the pending appeal, approved a new settlement that would allow the Sackler family to obtain voluntary third-party releases from the claimants in return for a larger financial contribution from the Sackler family, subject to its inclusion in a new reorganization plan to be submitted for Bankruptcy Court approval. Nevertheless, the payment by the Sackler family is still contingent on their relief from civil claims relating to Purdue Pharma’s opioid prescription business. Ultimately, absent Congress amending the Bankruptcy Code to explicitly allow or prohibit nonconsensual third-party releases in non-asbestos cases, it may be up to the Supreme Court, should it so choose, to have the final say on this issue, through the Purdue Pharma case following judgment by the Second Circuit or another bankruptcy case seeking to take advantage of this controversial bankruptcy tool.

____________________________

This alert should not be construed as legal advice or a legal opinion on any specific facts or circumstances. This alert is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The contents are intended for general informational purposes only, and you are urged to consult your attorney concerning any particular situation and any specific legal question you may have. We are working diligently to remain well informed and up to date on information and advisements as they become available. As such, please reach out to us if you need help addressing any of the issues discussed in this alert, or any other issues or concerns you may have relating to your business. We are ready to help guide you through these challenging times.

Unless expressly provided, this alert does not constitute written tax advice as described in 31 C.F.R. §10, et seq. and is not intended or written by us to be used and/or relied on as written tax advice for any purpose including, without limitation, the marketing of any transaction addressed herein. Any U.S. federal tax advice rendered by DarrowEverett LLP shall be conspicuously labeled as such, shall include a discussion of all relevant facts and circumstances, as well as of any representations, statements, findings, or agreements (including projections, financial forecasts, or appraisals) upon which we rely, applicable to transactions discussed therein in compliance with 31 C.F.R. §10.37, shall relate the applicable law and authorities to the facts, and shall set forth any applicable limits on the use of such advice.

[1] Deutsche Bank A.G. v. Metromedia Fiber Network, Inc., 416 F.3d 136, 141 (2d Cir. 2005).