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Executive Summary

  • The U.S. Supreme Court heard oral arguments this morning in a case arising out of Purdue Pharma’s bankruptcy on the legal question of whether third-party releases – which were granted in favor of the now-infamous Sackler family – are authorized by the Bankruptcy Code.
  • Many had expected the Supreme Court to be very skeptical of third-party releases, and many justices showed strong skepticism of that position today. Nonetheless, at least some justices took a more balanced approach to oral argument, challenging both sides with difficult and nuanced questions. One justice also appeared as a potential defender of third-party releases.
  • As noted in our mass-tort primers published earlier this year, we continue to believe that proponents of third-party releases probably face an uphill battle.
  • If the Supreme Court finds that third-party releases are unlawful, it will be one of most significant rulings in bankruptcy law in many years, perhaps in a generation. Such a ruling may complicate efforts by companies like Johnson & Johnson and Georgia Pacific to use the bankruptcy process to address talc and asbestos liabilities, respectively, and it may have the effect of reordering the expectations of what can be achieved in bankruptcy cases more generally.
  • We expect the Supreme Court to issue its decision in the first half of 2024.

Introductory Note

The U.S. Supreme Court heard oral arguments this morning in a case arising out of the bankruptcy of Purdue Pharma (“Purdue”) on the legal question of whether third-party releases – which were granted in favor of the now-infamous Sackler family – are authorized by the Bankruptcy Code. General information about the case, which is styled as Harrington v. Purdue Pharma, can be found here, and an audio transcript of the arguments can be found here. The Supreme Court’s forthcoming decision, which we expect in the first half of 2024, may be one of the most significant decisions in the area of bankruptcy law in many years.

By way of background, earlier this year we published a two-part series at the intersection of mass torts and bankruptcy. Part 1 of that series, which can be accessed here, explored Purdue and “third-party releases” that were granted in favor of the Sacklers, which owned Purdue. Part 1 also explored what “third-party releases” are, why they are used, and the Supreme Court’s decision to review the case. By contrast, Part 2 of that series, which can be accessed here, explored a series of other pending high-profile, mass-tort cases. Those cases include Georgia Pacific’s attempt to address its asbestos exposure through the bankruptcy of Bestwall; Johnson & Johnson’s attempt to address its talc exposure through the bankruptcy of LTL Management; and 3M’s attempt to address its earplug exposure with the bankruptcy of Aearo Technologies. Part 2 also explored the “Texas Two Step” divisional merger strategy that many companies have used to separate good assets from bad liabilities in an effort to protect overall equity and enterprise value. We encourage our readers to review Parts 1 and 2 for general background information on mass torts and bankruptcy.

This note discusses how Purdue got here; our impressions of how the Supreme Court may rule based on our review of the relevant legal pleadings and oral arguments from earlier today; and the broader implications of the Supreme Court’s ruling.

Brief History of Purdue Pharma Bankruptcy Cases

Purdue, which was once owned by the descendants of Drs. Mortimer and Raymond Sackler, is best known for developing and marketing OxyContin. Many believe that the marketing and sales tactics used for OxyContin contributed significantly to the opioid epidemic in the United States. As a result, both Purdue and the Sackler family have been the subjects of numerous government investigations and have been defendants in a myriad of lawsuits related to OxyContin. Notwithstanding this predicament, over the last 20 years, Purdue distributed approximately $11 billion to the Sacklers and their family trusts, many of which were outside the jurisdictional reach of the U.S. court system.

In late 2019, Purdue filed for bankruptcy to address the morass of litigation and its mounting liabilities. Purdue’s bankruptcy stayed all litigation against it, and the U.S. Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) extended the automatic stay to halt litigation against the Sacklers as well, even though they did not file their own individual bankruptcy cases.

One of the central pillars of the bankruptcy strategy was to obtain court approval of a global settlement between Purdue and the Sacklers. The settlement was to provide that the Sacklers would contribute a significant portion of their wealth to the Purdue bankruptcy estate in exchange for releases of claims that could be asserted against them by both (i) Purdue, on the one hand, and (ii) third parties like opioid victims and government entities, on the other hand (known as “third-party releases”). The theory behind the settlement was that the Sacklers’ contribution to the Purdue bankruptcy estate would augment the estate’s size so that significant, incremental value could be distributed to victims and for remediation efforts. The Sacklers ultimately agreed to contribute $4.325 billion in exchange for releases of civil liability against them. The settlement did not absolve the Sacklers of criminal liability.

The Bankruptcy Court approved the third-party release in conjunction with confirmation of Purdue’s plan of reorganization. The Bankruptcy Court reasoned that, if the settlement was not approved, creditors would have received little to no consideration from Purdue because (1) certain superpriority claims, which would be waived as part of the global settlement, would have priority of payment over victims, and (2) litigation against the Sacklers would prove to be fruitless because their wealth was beyond the reach of U.S. courts.

The Lower Court Appeals

On appeal, the U.S. District Court for the Southern District of New York vacated the Bankruptcy Court’s confirmation order in December 2021, concluding that third-party releases were not permitted under the Bankruptcy Code. On further appeal, however, a divided panel of the U.S. Court of Appeals for the Second Circuit (the “Second Circuit”) reversed again in May 2023 and upheld the settlement and third-party release.

The Second Circuit reasoned that §§ 105(a) and 1123(b)(6) of the Bankruptcy Code provide a statutory basis for third-party releases: that is, § 105(a) provides that “[t]he court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code],” and § 1123(b)(6) provides that “a [reorganization] plan may . . . include any other appropriate provision not inconsistent with the applicable provisions of this title.” The Second Circuit held that § 105(a) (which gives courts broad equitable powers) when coupled with residual powers identified in § 1123(b)(6) gives bankruptcy courts broad “residual authority” to modify credit-debtor relationships generally. The Second Circuit concluded that this residual authority includes the power to approve nonconsensual third-party releases.

Interestingly, by the time the Second Circuit ruled, nearly every constituency in the bankruptcy case—including the debtors, the official committee of unsecured creditors, various ad hoc groups, and most states—supported the plan and third-party release. The only key party opposing the release was the Office of the U.S. Trustee (the “U.S. Trustee”), which is a division of the Department of Justice that polices bankruptcy cases. The U.S. Trustee has no economic interest in the outcome of the case, yet the U.S. Trustee sought further review from the Supreme Court. The Supreme Court agreed to hear the case in August 2023.

Arguments at the Supreme Court

At the Supreme Court, the U.S. Solicitor General’s office argued on behalf of the U.S. Trustee. The Solicitor General made a series of arguments as to why third-party releases are not permitted under the Bankruptcy Code, namely that there is no provision of the Bankruptcy Code that expressly allows for third-party releases. In other words, the provisions relied on by Purdue and the Sacklers for the proposition that third-party releases are authorized is limited to altering the relationship between a debtor and a creditor, and not between creditors and non-debtors. By contrast, the parties in favor of a third-party releases – this includes nearly every party in interest, like Purdue, the tort victims, and the official committee of unsecured creditors – argued that the Second Circuit got it right: that is, §§ 105(a) and 1123(a)(6), when read together, gives bankruptcy courts broad latitude to grant third-party releases in limited contexts. In addition, a veritable ‘who’s who’ of influential lawyers and firms filed an avalanche of amici briefs (friend of the court briefs) on both sides of the debate. All of the briefs are available here.

At oral argument, which lasted nearly two hours, each Justice demonstrated a strong command of the issues and the implications of its ruling on other mass tort bankruptcies. However, they showed few cards about which way they were ultimately leaning. Chief Justice Roberts, for instance, started by questioning the Deputy Solicitor General why he did not argue the so-called ‘major-questions doctrine’ with respect to the lawfulness of third-party releases (this doctrine roughly stands for the proposition that courts should not presume Congress meant to address major political or economic questions without expressly stating so). Justice Thomas, for his part, seemed particularly interested in distinguishing between consensual and non-consensual third-party releasees and whether the Bankruptcy Code allows for either kind of release.

Justices Alito and Jackson seemed to be the most skeptical of third-party releases, posing complex questions about the interpretation of § 1123(b)(6) and potential constitutional issues tied to third-party releases. Justices Sotomayor, Kagan, and Barrett seemed to take a more balanced approach to questioning, challenging both sides with difficult and nuanced questions. By contrast, Justice Kavanaugh appeared as a potential defender of third-party releases, emphasizing that § 1123(b)(6)’s use of the word “appropriate” was a strong argument for proponents of third-party releases. Justice Kavanaugh also indicated that he thought the argument that the U.S. Trustee did not have standing in the case was strong (this issue was raised when the Court considered whether to grant certiorari). In the end, it appeared that it was not lost any Justice that victims might receive little or no recovery if the releases are not upheld, and that 97% of the victims supported the settlement. Some justices seemed more troubled by this than others, though, with at least some accepting the argument made by the Deputy Solicitor General that the Sacklers may just re-cut the deal if they lose.

Thoughts and Takeaways

As discussed in Part 1 of our primer, we believe that third-party releases can serve a valid purpose in the context of mass-tort bankruptcies. The alternative is the tort system, which is a fancy way of saying litigation on a case-by-case basis or through multi-district litigation (MDL). But the tort system can be inefficient; destroy value; lead to the proverbial race to the courthouse; implicate the holdout problem; and result in inconsistent judgments. We have few principled issues with third-party releases as a concept, and we think they can make for good policy if (1) the debtor and the party seeking the release have not otherwise abused the bankruptcy process and (2) creditors and tort victims are ultimately financially better off as a result of the third-party release. This is likely why Purdue’s plan of reorganization received nearly universal support from all parties in interest.

But what makes for good policy is often an entirely different question than what the law actually permits. We have previously observed that cobbling together various provisions of the Bankruptcy Code—in particular, §§ 105(a) and 1123(b)(6)—to find statutory support for the proposition that bankruptcy courts have some kind of ‘residual’ authority to approve nonconsensual third-party releases may not be well-received at the Supreme Court. Today’s arguments demonstrate that the justices have a strong command of the issues, and they fully appreciate how its ruling could impact other mass tort bankruptcies. Nonetheless, our initial assessment has not changed materially, and we continue to believe that proponents of third-party releases likely face an uphill battle, although they may find some support. We expect a decision in the first half of 2024.

Finally, we note that if the Supreme Court holds that third-party releases are unlawful, it could be one of most significant rulings in bankruptcy law in many years, perhaps in a generation. To be sure, it will complicate efforts by companies like Johnson & Johnson and Georgia Pacific to use the bankruptcy process to address talc and asbestos liabilities, respectively. But beyond mass torts bankruptcies, though, such a finding would also have the effect of reordering the expectations of what can be achieved in bankruptcy cases more generally, as parties may no longer be willing to make substantial contributions to a bankruptcy estate (for the benefit of creditors) if they cannot achieve global peace in exchange for those contributions. This is particularly true in cases when portfolio companies go into bankruptcy and non-debtor sponsors often demand releases as part of a global financial settlement to buy peace.

 

Mark Lightner, Esq.
Head of Special Situations Legal Research


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