Supreme Court Resolves Split in Lower Courts, Holds That Non-Consensual Third Party Releases Are Not Permitted in Chapter 11 Cases

On June 27, 2024, in one of the most significant appellate decisions regarding bankruptcy law since the adoption of the United States Bankruptcy Code in 1978, the United States Supreme Court settled a dispute among the federal circuit Courts of Appeals and held that a debtor in a reorganization case under chapter 11 of the Bankruptcy Code and its non-debtor joint tortfeasors may not effectuate a non-consensual third party release of the non-debtor tortfeasors, together with the discharge of the debtor from its tort claim obligations, through a confirmed plan of reorganization.

Before the Supreme Court was an appeal of a decision of the United States Court of Appeals for the Second Circuit in the notorious bankruptcy case In re Purdue Pharma, L.P., et al. Purdue Pharma, L.P. (“Purdue Pharma”) and several of its affiliates sought chapter 11 bankruptcy protection in the United States Bankruptcy Court for the Southern District of New York from the overwhelming amount of litigation and claims arising out of the sale and distribution to pharmacies, medical practices, and hospitals by Purdue Pharma of the addictive opioid OxyContin. Although it was the intent of Purdue Pharma and its majority owners, the Sackler family, to settle all current and future opioid litigation and tort claims against them, Purdue Pharma entered chapter 11 while the Sackler family themselves stayed out of bankruptcy. The Sacklers eventually agreed to personally contribute to the payment of claims in the bankruptcy case an amount which, as a result of negotiation and litigation, ultimately rose to between $5.5 billion and $6.0 billion in exchange for a release of the family from substantially all civil claims for opioid damages.

The Bankruptcy Court approved confirmation of a chapter 11 plan for Purdue Pharma which included the Sacklers’ contribution and provided for a release of claims against the Sacklers. The release was non-consensual in the sense that, as long as the class of tort claimant creditors voted to accept the chapter 11 plan by the requisite majorities, the release was binding on all class members irrespective of whether an individual claimant favored the release. On appeal, the District Court reversed and vacated the confirmation order, ruling that the Bankruptcy Code did not permit such third party releases. On appeal from the District Court, the Second Circuit reversed the District Court and affirmed the Bankruptcy Court’s approval of the Purdue Pharma chapter 11 plan, ruling that the Code did in fact permit the non-consensual third party releases. The Department of Justice, through the Office of the United States Trustee, appealed from the Second Circuit’s order, and the Supreme Court granted certiorari, hearing oral argument in December 2023.

Notably, at the time of the Supreme Court appeal, there was a significant split in the circuits on the question of whether third party releases are permitted in chapter 11 cases. A number of circuits, including the Second and Third Circuits, permitted third party bankruptcy releases, while others, including the Fifth and Ninth Circuits, disallowed third party bankruptcy releases. 

Third party bankruptcy releases, often (but certainly not exclusively) employed in mass tort liability bankruptcies, have been controversial since they were first used, and approved, in the Johns-Manville bankruptcy in the mid-1980s. Manville had sought bankruptcy protection against its asbestos litigation liability. The Manville releases pertained to insurers who contributed to the pot of money to be distributed to present and future claimants. Third party releases of joint tortfeasor contributors subsequently have been approved in large tort liability bankruptcy cases such as those of the Boy Scouts of America and several Catholic dioceses. Nonetheless, settled law permits the use of third party releases through a plan of reorganization only in extraordinary circumstances.

Third party releases contradict the idea that if you want bankruptcy protection and a bankruptcy discharge, you should file bankruptcy. There is no express provision permitting third party releases in the Bankruptcy Code, except a provision amended into the Code in 1994 permitting third party releases in asbestos mass tort bankruptcies. 

There are, however, strong policy and economic reasons for permitting third party releases in bankruptcy, particularly those involving mass tort defendants. They enable such debtors to reorganize and emerge from bankruptcy as operating entities offering macro- and microeconomic benefits locally and nationally, rather than liquidating, funding the plan with asset proceeds, and going out of business. The use of channeling injunctions (which stay litigation against non-debtor joint tortfeasors) in exchange for contribution to the chapter 11 payment fund ensures a fair distribution to claimants as an alternative to the free-for-all and races to the courthouse which will result in some for a few, nothing for the many, and countless more insolvencies among the joint tortfeasors. Toward that end, courts found Bankruptcy Code authority for third party releases in Section 105(a), which permits a bankruptcy court to issue any order that is appropriate to carry out the provisions of the Code, and Section 1123(b)(6), which provides that a chapter 11 plan may include any appropriate provision not inconsistent with the Code.

The Supreme Court, by a 5 to 4 majority, reversed the Second Circuit’s order and ruled that the release of the Sacklers violated bankruptcy law and thus the Purdue Pharma plan could not be confirmed. Justice Gorsuch wrote the opinion for the majority, which included the conservative Justices Thomas, Alito, and Barrett, and the liberal Justice Jackson. Chief Justice Roberts and Justices Kavanaugh, Kagan, and Sotomayor dissented.

For the majority, it was a matter of statutory interpretation of the Bankruptcy Code, and the Court rejected the argument that Section 1123(b)(6) broadly authorized non-consensual third party releases. Section 1123 enumerates the provisions that a chapter 11 plan must contain in order to be confirmable and, in subsection (b), enumerates provisions the plan may contain. The first five clauses of subsection (b) specifically reference the “debtor,” as in the debtor may settle claims, the debtor may modify the rights of secured claimants, and so forth. Thus, the Court determined that the “appropriate provisions not inconsistent with” the Code language in clause (6) only related to the chapter 11 debtor and not any third parties. 

The majority addressed the arguments stated in the dissent in favor of third party releases. The majority effectively affirmed that if a party wants the benefit of bankruptcy protection, it should seek bankruptcy protection, and that there is no real difference between a “discharge” of claims and a release of claims such as the Sacklers sought. The Court noted that in order for a chapter 11 debtor to win its discharge in bankruptcy, the debtor has to turn over all of its assets and claims for distribution to the creditors, while the Sacklers are not doing so yet receiving the benefit of the Purdue Pharma bankruptcy with a non-consensual release. The majority observed that when Congress wanted to, it could provide for non-consensual third party releases in the Bankruptcy Code, which Congress did for asbestos tort bankruptcies. Finally, the majority also observed that in the entire history of American bankruptcy law before the adoption of the Code, there had been no provision for third party releases, nor had Congress included such a specific provision in the Code in 1978.

The majority noted that it had expressly not ruled on the legitimacy of consensual third party releases, nor had it ruled on the legitimacy of non-consensual third party releases where the plan provides for 100 percent satisfaction of claims.

It is hard to see who wins from this result. The ruling does not just affect the proposed Sackler settlement. There are other pending mass tort chapter 11 cases which have proposed non-debtor contributor releases that now face uncertainty. For the tort claimants, the decision is a sow’s ear in a silk purse; while chapter 11 plans generally evaluate claims in the best light for the claims, now it is full speed ahead for litigation, and there is no guarantee that some or many claimants will get anything at all. Congress (as the majority observed) could do what it did for the asbestos litigant debtors and extend the ability to do non-consensual releases to all mass tort bankruptcy cases. In the meantime, debtors could try to push through fully consensual third party releases, which will be easier said than done.  

If you have any questions about the final rules, please contact a member of Harter Secrest & Emery’s Business Restructuring and Creditors’ Rights group.

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