Second Circuit Green Lights Purdue Pharma Chapter 11 Plan Containing Nonconsensual Third-Party Releases

• Published date: 27 July 2023
• Subject Matter: Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy
• Law Firm: Jones Day
• Author: Jane Rue Wittstein and Mark Douglas

There is longstanding controversy concerning the validity of third-party release provisions in non-asbestos trust chapter 11 plans that limit the potential exposure of various non-debtor parties involved in the process of negotiating, implementing and funding a plan. In the latest chapter of this debate, the U.S. Court of Appeals for the Second Circuit handed down a long-awaited ruling regarding the validity of nonconsensual third-party releases in the chapter 11 plan of pharmaceutical company Purdue Pharma, Inc. and its affiliated debtors (collectively, "Purdue"). In In re Purdue Pharma L.P., 69 F.4th 45 (2d Cir. 2023), the Second Circuit reversed a district court decision finding that the bankruptcy court lacked the power to approve a plan provision releasing the founding Sackler family from liabilities arising from Purdue's sale of opioids and affirmed the bankruptcy court order confirming Purdue's chapter 11 plan.

Chapter 11 Plan Releases

Section 524(e) of the Bankruptcy Code provides that, "[e]xcept as provided in subsection (a)(3) of this section [making the discharge injunction applicable to actions to collect against community property], discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt." Even so, chapter 11 plans confirmed by bankruptcy courts in certain circuits commonly include provisions that release various non-debtors from certain debtor liabilities.

Third-party releases can provide for the relinquishment of both prepetition and postpetition claims belonging to the debtor or non-debtor third parties (e.g., creditors) against various non-debtors. As such releases have become common features of chapter 11 plans, they also have become more controversial.

It is generally accepted that a chapter 11 plan can release non-debtors from claims of other non-debtor third parties if the release is consensual. See generally Collier on Bankruptcy ("Collier") ' 524.05 (16th ed. 2023) (citing cases). What constitutes consent, however, is sometimes disputed. Collier at ' 1141.02[5](b) (discussing various opt-out and opt-in mechanisms that have been attempted as a manifestation of consent for impaired and unimpaired creditors); Lisa M. Schweitzer, Third-Party Releases in Chapter 11 Plans: Key Considerations and Recent Developments, in Nuts and Bolts of Corporate Bankruptcy 2021, at 323 (Practising Law Institute Commercial Law and Practice Course Handbook Series, PLI Order No. A-1043, 2021) (same).

In addition, a plan that establishes a trust under section 524(g) of the Bankruptcy Code to fund payments to asbestos claimants can enjoin litigation against certain third parties (e.g., entities related to the debtor or its insurers) alleged to be liable for the conduct of, claims against, or demands on the debtor. See 11 U.S.C. ' 524(g)(4). Section 524(g) was added to the Bankruptcy Code in 1994 in the wake of the historic Johns-Manville and UNARCO Industries chapter 11 cases. It was enacted to provide explicit statutory authority for courts to issue channeling injunctions in respect of asbestos claims and demands, including those held by persons who have been exposed to asbestos but have not yet manifested any signs of illness.

The circuit courts of appeals are split as to whether a bankruptcy court has the authority, other than under section 524(g), to approve chapter 11 plan provisions that, over the objection of creditors or other stakeholders, release specified non-debtors from liability or enjoin dissenting stakeholders from asserting claims against such non-debtors. The minority view, held by the Fifth and Tenth Circuits-and until 2020, arguably the Ninth Circuit (see below)-bans such nonconsensual releases on the basis that they are prohibited by section 524(e) of the Bankruptcy Code. See Bank of N.Y. Trust Co. v. Official Unsecured Creditors' Comm. (In re Pac. Lumber Co.), 584 F.3d 229 (5th Cir. 2009); Resorts Int'l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394 (9th Cir. 1995); In re W. Real Estate Fund, Inc., 922 F.2d 592 (10th Cir. 1990); see also Blixseth v. Credit Suisse, 961 F.3d 1074, 1083-84 (9th Cir. 2020) (suggesting, contrary to Lowenschuss and other previous rulings, that section 524(e) does not preclude certain non-debtor plan releases of claims that are not based on the debt discharged by the plan), cert. denied, 141 S. Ct. 1394 (2021).

On the other hand, the majority of the circuits that have considered the issue have found such releases and injunctions permissible under certain circumstances. See SE Prop. Holdings, LLC v. Seaside Eng'g & Surveying, Inc. (In re Seaside Eng'g & Surveying, Inc.), 780 F.3d 1070 (11th Cir. 2015); In re Airadigm Commc'ns, Inc., 519 F.3d 640 (7th Cir. 2008); In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002); In re Drexel Burnham Lambert Grp., Inc., 960 F.2d 285 (2d Cir. 1992); In re A.H. Robins Co., Inc., 880 F.2d 694 (4th Cir. 1989). For authority, these courts generally rely on section 105(a) of the Bankruptcy Code, which authorizes courts to "issue any order...