Non-Debtor Third-Party Releases Allowed in Certain Circumstances, Says U.S. Second Circuit Court of Appeals

By Matt Stolz

Federal appeals courts are split on the question of when, if ever, a bankruptcy court can release the debts or potential debts of a party other than the bankrupt debtor through a plan of reorganization or sale of assets.  The opinion of the U.S. Court of Appeals for the Second Circuit in In re Purdue Pharma, Inc., No. 22-110-bk(L) (2d Cir. May 30, 2023) is the most recent high-profile decision to address the question, holding that third-party releases are permissible in certain circumstances.  Though Purdue did not involve a dispute with a union or union-affiliated fund, unions and funds may expect to see an increased number of bankruptcy cases where non-debtor third parties, like company owners or affiliated entities, seek releases through a bankruptcy plan.

In Purdue, the company entered bankruptcy saddled with heavy criminal and civil liabilities for its sale and marketing of opioids.  According to the court, members of the Sackler family, who have long controlled Purdue and whose trusts and holding companies received $11 billion in distributions from Purdue between 2008 and 2016, also faced potential liability for their role in Purdue’s misconduct, though they did not file for bankruptcy.  In provisions of a plan of reorganization confirmed by the bankruptcy court, the Sacklers obtained a third-party release clearing them of all liabilities that could arise from Purdue’s pre-bankruptcy conduct.  In exchange, the Sacklers agreed to contribute $5.5-6.0 billion to the bankruptcy estate to pay Purdue’s creditors, including victims of the opioid epidemic.

On appeal, the Second Circuit approved the third-party release of the Sacklers over the objections of the United States Trustee and certain dissenting creditors.  The Second Circuit’s opinion addressed two questions: 1) Does the Bankruptcy Code authorize the release of the debts of third parties? and 2) If so, under what circumstances?

The Second Circuit answered yes to the first question, citing a catchall Bankruptcy Code section permitting plans of reorganization to include any “appropriate provision” not otherwise proscribed by the Code.  11 U.S.C. § 1123(b)(6).  This ruling puts the Second Circuit in line with a growing list of federal appeals courts—the Third, Fourth, Sixth, Seventh, and Eleventh—that hold that the Bankruptcy Code authorizes third-party releases in at least some circumstances.  The Fifth, Ninth, and Tenth Circuits have held that the Code does not authorize third-party releases, and the First, Eighth, and D.C. Circuits have not directly ruled on the issue.  (The Supreme Court has agreed to take up an appeal of the Purdue case in the coming months, and the Supreme Court’s decision will likely resolve the circuit split.)

The Second Circuit in Purdue outlined a multi-factor test for assessing the propriety of a proposed third-party release.  The factors include whether the release is essential to the success of the plan of reorganization, whether the third party is contributing substantial assets to the estate, and whether the affected creditors support the plan and the release.

The Second Circuit approved the third-party release of the Sacklers, holding that the release was essential to the success of the plan, which enjoyed the near-unanimous support of the creditors.  The court held that without the release, Purdue would end up mired in litigation over its duty to indemnify the Sacklers for their personal liability, and without the Sacklers’ contribution, Purdue’s estate would not be sufficient to cover the government’s priority claims, and the opioid creditors would likely walk away empty handed.  The Second Circuit was also clearly impressed by the size of the Sacklers’ contribution, noting that $5.5-$6.0 billion would be “the largest contribution in history” for a third-party release.

Whether or not the Bankruptcy Code permits third-party releases is a tricky question of statutory interpretation which the Supreme Court will likely address when it takes up the appeal of the Purdue case.  In those cases where third-party releases are permitted, bankruptcy creditors, including unions and their affiliated pension and benefit funds, must think strategically about when to support or oppose third-party releases negotiated as part of a reorganization plans.  As with all settlement negotiations, unions should consider what they and their members stand to gain or lose from a proposed release, and what leverage may or may not be available to reshape or block the plan.

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