The Supreme Court’s landmark decision in Harrington v. Purdue Pharma L.P. – holding that the Bankruptcy Code does not authorize the release of third-party claims against non-debtors in a reorganization plan without the consent of the affected claimants – will have a lasting impact on mass tort bankruptcy cases and likely nullifies one of the primary benefits of the so-called “Texas Two-Step” strategy: obtaining third-party releases of the debtor entity’s non-debtor affiliates. In Part I of this article, which can be found here, we discussed the limitations of the Texas Two-Step[1] and why “structural optimization” is an attractive out-of-court alternative to the bankruptcy system for dealing with mass tort liability, particularly in solvent situations. In the wake of the Purdue decision, such out-of-court options are likely to become even more advantageous in protecting large corporations from mass tort liability.

In 2019, Purdue Pharma L.P. (Purdue), the drug maker of the brand name opioid, OxyContin, filed for chapter 11 bankruptcy protection due largely to a series of lawsuits and state enforcement actions alleging that Purdue, and its long-time owners the Sackler family, had intentionally misled the public about how addictive OxyContin was compared to other pain medications. After many years of litigation, Purdue ultimately filed for bankruptcy and sought court approval of a plan that, among other things, proposed to settle and release the claims of individual tort plaintiffs and state attorneys general against the company as well as the Sackler family. The Sackler family had agreed to contribute $4.325 billion to Purdue’s bankruptcy estate in exchange for the release of all claims against them. The bankruptcy court approved the reorganization plan but the decision was overturned by the district court, which held that the Bankruptcy Code does not permit the non-consensual release of third-party claims against the Sackler family, who themselves were not in bankruptcy. The Sackler family appealed the district court decision and pledged to contribute additional amounts up to a total of approximately $6 billion to Purdue’s bankruptcy estate if the eight objecting states and the District of Columbia withdrew their objections to Purdue’s reorganization plan. Relying on section 1123(b)(6) of the Bankruptcy Code, which provides that a reorganization plan may “include any other appropriate provision not inconsistent with the applicable provisions of this title,” the Second Circuit found in favor of the Sackler family and reversed the district court decision.

The Second Circuit decision was subsequently appealed solely by the Office of the United States Trustee (which is an arm of the DOJ that serves as a watchdog over bankruptcy cases) despite each group of claimants and the state attorneys general having accepted the increased settlement offer from the Sackler family in exchange for the proposed releases. Writing for the majority, Justice Gorsuch disagreed with the Second Circuit’s holding and found that a bankruptcy plan that discharges non-debtor claims against other non-debtors on a non-consensual basis is not authorized under the Bankruptcy Code. The Court’s opinion further explained that section 1123(b) of the Bankruptcy Code only permits bankruptcy courts to discharge claims “without consent only to the extent that such claims concern the debtor,” which afforded the Sackler family no protection since they were not debtors in the bankruptcy cases. Moreover, the Court drew support for its holding from the fact that Section 524(g) of the Bankruptcy Code specifically permits releases of third-party claims against non-debtors in the context of asbestos liability, suggesting that Congress expressly permitted such non-debtor releases solely in asbestos cases because such releases were not generally permitted under the other Bankruptcy Code provisions relied upon by Purdue and the Sackler family.

The Court expressly stated that its decision would not apply retroactively to bankruptcy plans that were effective and substantially consummated, nor affect consensual third-party releases under bankruptcy plans. However, the Court declined to provide guidance on what qualifies as a consensual release of claims against a third-party non-debtor in reaching its decision.

The dissent, written by Justice Kavanaugh, asserted that the majority opinion “restricts the long-established authority of bankruptcy courts to fashion fair and equitable relief for mass-tort victims.” The dissent emphasized the significance of the Bankruptcy Code’s purpose of resolving collective action problems and the broad discretion vested in bankruptcy courts to achieve that purpose. The dissent then analogized mass-tort cases to collective action problems, in support of its position that Purdue’s reorganization plan aligned with such purpose under the Bankruptcy Code.

The Court’s decision likely renders the bankruptcy process significantly less advantageous to companies attempting to deal with mass tort liabilities. Historically, such companies would engage in a “submission” exercise involving significant resources to litigate the claims to conclusion and run off the liability and, if that effort failed, file the entire corporate organization for bankruptcy protection. More recently, solvent companies have tried to take advantage of the bankruptcy process without subjecting the entire corporate group to the bankruptcy process by implementing the Texas Two-Step whereby a company reorganizes its corporate structure through divisive mergers under Texas state law to cabin all the liabilities into one or more newly formed solvent subsidiaries. The subsidiaries holding the liabilities then file for bankruptcy and seek to discharge the liability and, important to this discussion, also obtain releases for the parent entity and other corporate affiliates that are not in bankruptcy. Purdue has likely rendered this latter benefit unobtainable and therefore the Texas Two-Step strategy ineffective, especially if the liability does not relate to asbestos (which is uniquely governed by Section 524(g) of the Bankruptcy Code).

As a result, we believe the out-of-court alternative of structural optimization in many instances will be the best way to comprehensively and permanently deal with mass tort liabilities. As detailed further in Part I, structural optimization aims to segregate within the corporate structure all potential liabilities from go-forward operating or other valuable assets, leaving such liability behind and transferring excess assets into entities that are distinctly separate. This way, if done properly, when a claim is brought later by a plaintiff, such claim should only exist against the isolated entity. To accomplish this goal, every entity in the corporate structure that has actual or potential exposure to the relevant liability is identified and its assets and liabilities analyzed. Then, the assets that sit above the solvency line are moved out of that entity and into a newly formed entity – one that has no exposure. This process is repeated until all entities with potential liability are left with only that liability and a corresponding amount of cash, notes, or other non-operational assets to support such liability and remain solvent to avoid fraudulent transfer risk. This can have powerful results, especially when done years in advance of any claims arising and also protects the “healthy” entities in the company much better than the bankruptcy process, particularly now that the Court’s decision in Purdue would, outside of asbestos cases, prohibit non-consensual third-party releases.

Authored by John Beck & Chris Donoho with assistance from Nicholas Wynne (summer associate)

References

[1] Since Part I of our Article, the Texas Two-Step has garnered Congressional push back.  On July 23, 2024, a bi-partisan group of U.S. Senators introduced a bill titled “Ending Corporate Bankruptcy Abuse Act of 2024” with the intent of deterring Texas Two-Step bankruptcies, saying in a statement that wealthy companies should not be able to stop lawsuits by moving their liabilities into a bankrupt shell company.