December 21, 2021 - by Elliot Ganz. Updated on January 6, 2022. In late December, SDNY District Court Judge Colleen McMahon, in a remarkable 146 page opinion, overturned the confirmation of Purdue Pharma’s plan of reorganization. Besides the direct and immediate implications for that important case, the ruling could have significant implications for reorganizations of companies with broadly syndicated and direct market leveraged loans. In a nutshell, the court ruled that the lynchpin of the Purdue reorganization plan, broad “third-party” releases of members of the Sackler family that protected them against assertions of any direct claims, were nowhere authorized by any section of the Bankruptcy Code, “not in its express text (which is conceded); not in its silence (which is disputed); and not in any section or sections of the Bankruptcy Code that, read singly or together, purport to confer generalized or ‘residual’ powers on a court sitting in bankruptcy.” (Please see this article from Schulte Roth & Zabel for a good summary and analysis of the case).
In the bankruptcy court below, Judge Robert Drain concluded that Section 105(a) of the Bankruptcy Code, together with Sections 1123(b)(5) and (6) and Section 1129, gave him the equitable or residual statutory authority to approve the non-consensual third party releases. Judge McMahon disagreed, finding that such provisions, either alone, or in combination, gave the court no such authority and that the US Court for of Appeals for the Second Circuit had never taken a contrary position. Indeed, relying on U.S. Supreme Court precedents such as In re Jevic and In re Radlax, the court found that there is no such thing as equitable authority or residual authority that is not tethered to “some specific, substantive grant of authority in the Bankruptcy Code” and found no such authority in the Bankruptcy Code for third-party releases except under Section 524(g) which is limited by its terms to asbestos cases.
Implications. It goes without saying that this decision throws a monkey wrench into the entire Purdue Pharma reorganization process and it is impossible to predict how it will turn out. Purdue has appealed and the parties agreed, in the meantime, to engage in mediation. Because there is a direct conflict among the federal circuit courts on the issue of non-debtor releases (and the doctrine of equitable mootness will not apply), the case could, if not settled, eventually reach the Supreme Court. Beyond that, debtors in typical corporate restructurings (rather than mass tort cases), particularly those owned by private equity firms, are likely to continue to avoid filing for bankruptcy protection in the Southern District of New York (a trend that has already been in place for some time). And, if the 2nd Circuit and/or the Supreme Court affirm the court’s view on the narrowness of courts’ general Section 105(b) equitable or residual authority, the implications on reorganization practice, perhaps even beyond the limited issue of third-party releases, could be profound. We will continue to follow this case as it develops.