[Purdue Pharma Bankruptcy Series] Are Third-Party Releases Proper?

Editor’s Note: On August 10, 2023, the Supreme Court of the United States agreed to hear the appeal of the bankruptcy of Purdue Pharma. In its grant of certiorari, the Supreme Court asked the parties to brief and argue “[w]hether the Bankruptcy Code authorizes a court to approve, as part of a plan of reorganization under Chapter 11 of the Bankruptcy Code, a release that extinguishes claims held by nondebtors against nondebtor third parties, without the claimants’ consent.” Following on the BRT’s previous coverage of recent developments in mass tort bankruptcies, the next few posts will address Purdue’s bankruptcy in particular and the issues raised by third-party releases and mass tort bankruptcies more generally. This week’s post features two articles, each with different views on the propriety of third-party releases and the breadth of the power of bankruptcy courts more generally.

For some prior coverage on the BRT regarding Purdue Pharma’s bankruptcy, please see articles here (by Jonathan Lipson, Adam Levitin, and Stephen Lubben), here (by William Organek), here (by Marshall Huebner and Marc Tobak), and here (by Jonathan Lipson).

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Post One: Coerced Releases: Are Non-Consensual Third Party Releases in Bankruptcy Code Chapter 11 Cases Allowed by The Constitution and the Bankruptcy Code?

By Martin J. Bienenstock and Daniel S. Desatnik (Proskauer Rose LLP)

Chapter 11 reorganization plans allocate the reorganized debtor’s value among its creditors and shareholders.  When the reorganized debtor needs more capital to survive, the main shareholders sometimes provide it on the condition the court compel all the debtor’s creditors and other shareholders to release them from claims related to the debtor (“coerced releases”).  For instance, some creditors may contend the main shareholders injured them by defrauding them into extending credit to the debtor.  This article examines the critical issues litigants have not raised and courts have not considered regarding whether federal courts can deprive the debtor’s dissenting creditors and minority shareholders of their individual claims against the debtor’s main shareholders without violating the Bankruptcy Code and the Constitution. 

Coerced releases violate the following constitutional rights:

1. Violation of Fifth Amendment Substantive Due Process.  The Fifth Amendment provides entities suffering takings of their property for public purposes are entitled to just compensation.  As compared to eminent domain proceedings, the coerced releases have been ordered without allowing the parties whose claims are taken to prove the value of their individual claims and without determining the value they receive, let alone proof it amounts to just compensation.   
2. Deprivation of Fundamental Rights.  One of the unenumerated, fundamental rights protected from denial and disparagement by its exclusion from the Bill of Rights and repeatedly recognized by the Supreme Court is the right to sue, because liberty and property rights are meaningless if their violations cannot be remedied in court.  Coerced releases eliminate the creditors’ and shareholders’ rights to sue the shareholders receiving the coerced releases.  The Supreme Court has rejected deployment of the bankruptcy power to deprive litigants of fundamental rights even when compelling business reasons exist.
3. Violation of Fifth Amendment Procedural Due Process.  The constitutionality of bankruptcy law depends on a fair distribution of the debtor’s assets to the stakeholders suffering discharge of their claims.  Shareholders receiving coerced releases, however, do not make their full assets available for distribution to their creditors.  Therefore, shareholders are left with assets for themselves, and could pay their personal creditors in full, while they pay an undetermined fraction of the discharged claims.  That distribution scheme has no attributes of fairness compared to the distribution schemes in the Bankruptcy Code.
4. Violation of Article III Judicial Power.  Withdrawal from Article III judicial cognizance of the creditors’ and shareholders’ tort and contract claims against shareholders for money damages violates the Article III judicial power.
5. Violation of Separation of Powers Principle.  If the Bankruptcy Code authorizes courts to deprive creditors and shareholders of their rights to sue the released shareholders in exchange for what the released shareholders contribute to the reorganization, Congress violated the separation of powers principle by legislating the judicial branch can discard the common law and impose a remedy without a jury trial determining the released claims. 

The Bankruptcy Power neither authorizes nor condones any of the foregoing violations. 

The Bankruptcy Code, by limiting chapter 11 plans to provisions consistent with title 11, does not authorize coerced releases, except in asbestos cases.

Click here to read the full article. 

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Post Two: For Bankruptcy Exceptionalism

By Jared Mayer (University of Chicago Law School)

In his recent article, Against Bankruptcy Exceptionalism, Professor Jonathan M. Seymour argues that bankruptcy courts have wrongly bucked the Supreme Court’s trend toward textualism. Bankruptcy courts believe that they need to approach the Bankruptcy Code pragmatically in light of the unique dynamics inherent in bankruptcy practice and therefore adopt purposivist, equitable, or “rough justice” approaches to facilitate that kind of pragmatism—an attitude that Professor Seymour calls “bankruptcy exceptionalism.” Professor Seymour’s argument runs along two different axes: approaches to statutory interpretation and bankruptcy courts’ powers. The more a court strays from the Code’s text, the more power it will be able to exercise, and that power soon gets out of hand. Exceptionalist interpretations aren’t reserved for “rare cases.” Nontextualist approaches to the Code, rather, beget interpretations that are initially deemed “exceptions,” but snowball into strategies that every seasoned bankruptcy lawyer will turn to when possible. Professor Seymour bemoans this development and asks whether anything about bankruptcy law or practice justifies bankruptcy exceptionalism. He doesn’t think so.

In this Essay, I argue that bankruptcy law is exceptional, and bankruptcy exceptionalism begins with the Code. Even within its own confines, the Bankruptcy Code cloaks bankruptcy courts with unparalleled powers. For example, the Code imposes automatic stays on many attempts to obtain property from the estate, modifies parties’ prepetition agreements, and allows debtors to sell their assets free and clear of any claims or interests that might encumber those assets. These powers are unrivaled in the federal and (certainly) state arsenals.

Bankruptcy courts are vested with these powers to address the complex dynamics that give rise to, and inhere in, bankruptcy proceedings. Bankruptcy courts must shepherd the parties toward achieving a resolution that works for most, if not all, of them. Implementing those solutions may require bankruptcy courts to find some play in the Code’s text. By the same token, bankruptcy proceedings give parties the opportunity to act opportunistically; that is, to engage in activity that squanders value ex post and is hard to detect ex ante. Bankruptcy exceptionalism allows bankruptcy courts to attack this kind of opportunistic behavior. And in my view, the Supreme Court’s opinion in Czyzewski v. Jevic Holding Corp. (2017) reflects the Court’s recognition that bankruptcy cases are exceptional and legitimizes bankruptcy exceptionalism.

It’s true that creative interpretations come at a cost. Professor Seymour rightly notes that parties can use bankruptcy courts’ lax attitude toward the Code’s text to normalize harmful or costly practices. But they can do so even within the Code’s text. While we may recoil at abuses of the bankruptcy process, we should tackle those abuses as they arise, not by abandoning bankruptcy exceptionalism.

Click here to read the full article.