A popular bankruptcy manoeuvre gets upended by the US Supreme Court

Private equity titans, industrial CEOs and pharmaceutical manufacturers assiduously avoid bankruptcy court. But when their companies have fallen into financial distress, they have found it a useful avenue to manage their own liabilities. 

In recent years, US bankruptcy law has evolved to seemingly give judges the broad power to cut deals where parties linked to the bankrupt entity could in effect buy their way out of future lawsuits. Getting money to victims quickly, those judges ruled, was worth slamming the door on the chance to chase those third parties for more.

Now, the US Supreme Court has pushed back. In a landmark 5-4 ruling on Thursday it found US bankruptcy courts had gone too far in approving such horse-trading over so-called “non-consensual third-party releases”, invalidating a hard-fought $6bn settlement struck by members of the Sackler family to settle the 2019 bankruptcy of opioid maker Purdue Pharma.

Purdue had become one of the most controversial companies in US history, accused of fuelling the opioid crisis that has claimed the lives of more than 200,000 Americans. The bankruptcy process was supposed to be a model process for holding corporate wrongdoers accountable — albeit an imperfect one.

The Sacklers — who owned and operated the OxyContin maker for decades — had not themselves filed for bankruptcy. But they agreed to contribute $6bn to pay claims related to the painkiller, in exchange for an agreement that released them from future civil liability.

The terms were eventually agreed to by thousands of opioid victims as well as US states, municipalities and Native American tribes with claims against the company. Only a handful of objectors remained, including the Biden administration, which took its appeal all the way to the Supreme Court.

At the centre of its objections was the non-consensual third-party release, meaning it was not agreed by all the creditors or claimants but was previously approved by the court. These have become a common feature of many messy restructuring cases — private equity firms accused of fraudulent conveyance, for example, could contribute to a settlement and then be let off the hook for future lawsuits.

The Supreme Court pointed out that this practice was nowhere to be found in the bankruptcy statute beyond a specific rule for cases involving asbestos — the cancer-causing substance that led to a ruinous number of legal claims against many companies involved in its manufacture and use.

The Supreme Court held that merely greasing the wheels to get deals done quickly was not enough to make the practice legally permissible. Whether it should be was a question for Congress to address, it added.

“This court is the wrong audience for such policy disputes. Our only proper task is to interpret and apply the law; and nothing in present law authorises the Sackler discharge,” Justice Neil Gorsuch wrote for the majority.

The key advantage to using bankruptcy court as a way of resolving a mass of claims is its relative efficiency in reaching a unified global settlement among a sprawling array of parties vying for a limited pot of assets. In his dissent, Justice Brett Kavanaugh lamented the practical effects of the majority’s decision, leaving Purdue claimants to restart negotiations or bring one-off lawsuits.

“Opioid victims are now deprived of the substantial monetary recovery that they long fought for and finally secured after years of litigation,” wrote Kavanaugh. 

“Bankruptcy seeks to solve a collective-action problem and prevent a race to the courthouse by individual creditors who, if successful, could obtain all of a company’s assets, leaving nothing for all the other creditors.”

Anthony Casey, a law professor at the University of Chicago who has been a vocal supporter of mass tort resolution in Chapter 11 bankruptcy, said that Thursday’s decision meant “there is now one less tool for resolving large tort cases with future claimants and powerful holdouts. 

“In cases like Purdue, less money will be offered and the state attorneys-general will take larger chunks of it,” he said.

The limitations of using bankruptcy to resolve mass torts has already been demonstrated in recent cases involving Johnson & Johnson’s talc powder and 3M’s military ear plugs. In both instances, the companies attempted to use the bankruptcy court to consolidate and resolve thousands of injury claims.

3M tried to move thousands of claims into bankruptcy court to resolve them, but that attempt was blocked by a federal judge. It has since offered $6bn to resolve those case in a more conventional mass tort settlement.

J&J has tried to execute a “Texas two-step” to hive off talc cases into a separate bankruptcy vehicle, but been denied by a federal appeals court. It is now attempting to engineer a settlement with plaintiffs before returning to bankruptcy court with a fully agreed deal in hand.

Those case studies provide some hope that companies and victims can find common ground relatively quickly without requiring a bankruptcy judge to prod a settlement — although the particular circumstances of the pair may not be applicable to other product-liability situations.

For private equity firms that had relied on liability releases to walk away unscathed from companies in their portfolio that fell into bankruptcy, the Supreme Court’s ruling will force them to rethink how to protect themselves from lawsuits going forward.

“The big brains of the bankruptcy bar are going to be thinking about how to do that in a matter that’s consistent with this ruling,” said Daniel Shamah, a law partner at Cooley who specialises in restructuring. “I don’t think this is the end of bankruptcy practice as we know it. That would be premature.”

Some experts believe that the Supreme Court’s decision, however painful to Purdue victims, will chasten powerful actors whom they believe have been able to get sweetheart deals in bankruptcy that Congress had not sanctioned.

“The vast majority of people in America would never be permitted to use bankruptcy so flexibly,” said Melissa Jacoby, a law professor at the University of North Carolina and the author of a recent book, Unjust Debts, about the inequities in the US bankruptcy system.