Congressional Committees Propose Changes to Bankruptcy Code Prohibiting Non-Consensual Releases of Third Parties and Limiting Other Important Bankruptcy Tools

By Michael J. Cohen, Michael A. Rosenthal & Matthew J. Williams (Gibson Dunn)

The recent decision in In re Purdue Pharma did not uphold the third-party releases in the bankruptcy court’s approved plan. This post discuss the third-party releases issue.

— Harvard Law School Bankruptcy Roundtable Editors

Michael J. Cohen
Michael A. Rosenthal
Matthew J. Williams

On July 28, 2021, certain Democratic members of Congress, primarily in response to the $4.325 billion contribution made by the Sackler family to fund the settlement underpinning Purdue Pharma’s chapter 11 plan, introduced the Nondebtor Release Prohibition Act of 2021 (the “NRPA”), which proposes to amend the Bankruptcy Code to (i) prohibit the use of non-consensual third party releases in chapter 11 plans, (ii) limit so-called “Section 105” injunctions to stay lawsuits against third parties to a period no greater than 90 days after the commencement of a bankruptcy case, and (iii) provide a ground for dismissing a bankruptcy case commenced by a debtor that was formed within 10 years prior to such case via a divisional merger that separated material assets from liabilities.

When viewed against the backdrop of current complex chapter 11 practice, the NRPA is a flawed remedy for issues for which alternative means of redress already exist. First, the proposed elimination of the important bankruptcy tools of non-consensual third party releases and Section 105 injunctions – each of which is extraordinary in nature and only permitted in the rarest of circumstances – is a blunt force measure that threatens to vitiate the longstanding bankruptcy policy of favoring settlements over interminable value-destructive litigation.  Second, the loss of these tools may cause inequitable disruption in currently pending cases and stymie the implementation of critical creditor-supported strategies to resolve the most difficult cases going forward.  Moreover, a per se prohibition against non-debtor releases would contravene core bankruptcy principles by elevating the interests of a minority of creditors who would otherwise be bound to the terms of a chapter 11 plan containing such a release that is supported by the requisite majorities required under the Bankruptcy Code.  Third, while the disincentive against divisional mergers would affect a far more limited set of cases, it appears that the harm raised by some divisional mergers that are followed by bankruptcy may be adequately addressed through clarifying the applicability of fraudulent transfer law to challenge these transactions.

On November 3, 2021, the House Judiciary Committee sent the NRPA to the House floor for further consideration; the Senate Judiciary Committee has yet to act on the bill.  For more detail on the NRPA and our analysis of the bill, please find the full article here.

Mandatory Aggregation of Mass Tort Litigation in Bankruptcy

By Ralph Brubaker (James H.M. Sprayregen Professor of Law, University of Illinois College of Law)

The recent decision in In re Purdue Pharma did not uphold the third-party releases in the bankruptcy court’s approved plan. This post discuss the third-party releases issue.

— Harvard Law School Bankruptcy Roundtable Editors

Ralph Brubaker

This response to Professor Lindsey Simon’s Bankruptcy Grifters article challenges the controversial practice at the epicenter of the bankruptcy grifter phenomenon that Simon critiques: so-called nonconsensual nondebtor (or third-party) “releases” and “channeling” injunctions that discharge the mass tort obligations of solvent nondebtor entities who have not themselves filed bankruptcy. These nondebtor releases are an illegitimate and unconstitutional exercise of substantive lawmaking powers by the federal courts that contravenes the separation-of-powers limitations embedded in both the Bankruptcy Clause and Erie’s constitutional holding. The federal courts have manufactured out of whole cloth the unique, extraordinary power to impose mandatory non-opt-out settlement of a nondebtor’s mass tort liability on unconsenting tort victims through the bankruptcy proceedings of a codefendant. The bankruptcy “necessity” that supposedly justifies this astounding and unique settlement power—to mandate nonconsensual non-opt-out “settlements” that are otherwise impermissible and unconstitutional—is (at best) naive credulity or (at worst) specious sophistry.

Nonconsensual nondebtor releases are not “necessary” for the bankruptcy process to facilitate efficient aggregate settlements of the mass tort liability of both bankruptcy debtors and nondebtor codefendants. The bankruptcy jurisdiction, removal, and venue provisions of the Judicial Code already contain the essential architecture for mandatory, universal consolidation of tort victims’ claims against both bankruptcy debtors and nondebtor codefendants. Bankruptcy can be an extremely powerful aggregation process that facilitates efficient (and fair) settlements of the mass tort liability of nondebtors, even (and especially) without nonconsensual nondebtor releases, particularly if the Supreme Court elucidates the full expanse of federal bankruptcy jurisdiction. Nondebtor releases are an illicit and unconstitutional means of forcing mandatory settlement of unconsenting tort victims’ claims against solvent nondebtors, and the Supreme Court should finally resolve the longstanding circuit split over the permissibility of nonconsensual nondebtor releases by categorically renouncing them.

The full article is available here and is forthcoming in the Yale Law Journal Forum.

Bankruptcy Grifters

By Lindsey Simon (University of Georgia School of Law)

The recent decision in In re Purdue Pharma did not uphold the third-party releases in the bankruptcy court’s approved plan. This post discuss the third-party releases issue.

— Harvard Law School Bankruptcy Roundtable Editors

Lindsey Simon

Grifters take advantage of situations, latching on to others for benefits they do not deserve. Bankruptcy has many desirable benefits, especially for mass-tort defendants. Bankruptcy provides a centralized proceeding for resolving claims and a forum of last resort for many companies to aggregate and resolve mass-tort liability. For the debtor-defendant, this makes sense. A bankruptcy court’s tremendous power represents a well-considered balance between debtors who have a limited amount of money and many claimants seeking payment.

But courts have also allowed the Bankruptcy Code’s mechanisms to be used by solvent, nondebtor companies and individuals facing mass-litigation exposure. These “bankruptcy grifters” act as parasites, receiving many of the substantive and procedural benefits of a host bankruptcy, but incurring only a fraction of the associated burdens. In exchange for the protections of bankruptcy, a debtor incurs the reputational cost and substantial scrutiny mandated by the bankruptcy process. Bankruptcy grifters do not. This dynamic has become evident in a number of recent, high-profile bankruptcies filed in the wake of pending mass-tort litigation, such as the Purdue Pharma and USA Gymnastics cases.

This Article is the first to call attention to the growing prevalence of bankruptcy grifters in mass-tort cases. By charting the progression of nondebtor relief from asbestos and product-liability bankruptcies to cases arising out of the opioid epidemic and sex-abuse scandals, this Article explains how courts allowed piecemeal expansion to fundamentally change the scope of bankruptcy protections. This Article proposes specific procedural and substantive safeguards that would deter bankruptcy-grifter opportunism and increase transparency, thereby protecting victims as well as the bankruptcy process.

The full article is available here and is forthcoming in the Yale Law Journal.

COVID-19 Debt and Bankruptcy Infrastructure

By Robert K. Rasmussen (USC Gould School of Law)

Robert Rasmussen

The COVID pandemic put unprecedented pressure on all economies around the world. Many predicted that this economic dislocation would lead to an unprecedented number of corporate bankruptcies. This did not happen. The American government and other governments responded with extraordinary measures. While these measures allowed companies to ride out the worst of the pandemic, they did have consequences. Many large companies were left with unprecedentedly large amounts of debt on their balance sheets.

 Perhaps a robust economy will allow companies to grow their way out from under their debt burden. But perhaps not. To prepare for the possible future increase in large companies filing for bankruptcy, Congress should act now to build up a bankruptcy infrastructure sufficient to handle an influx in cases. Specifically, Congress should require that every circuit create a “business bankruptcy panel” designed to administer the Chapter 11 filing of large companies. As is well-known, three bankruptcy districts currently serve as dominant venues for large cases – the District of Delaware, the Southern District of New York and the Southern District of Texas. It is by no means clear that these three courts could handle a significant increase in caseloads. Creating expertise across the country would help prepare the system for any future rise in cases. A secondary benefit of this reform is that it may also ameliorate some of the concerns that have been raised over the years by the dominance of a small number of venues for large corporate cases.

The full article is available here.

Mandatory Disclosure in Corporate Debt Restructuring via Schemes of Arrangement: A Comparative Approach

By Casey Watters (Bond University) and Wai Yee Wan (City University of Hong Kong)

Casey Watters
Wai Yee Wan

Creditors often face significant information asymmetry when debtor companies seek to restructure their debts. In the United Kingdom, it is mandatory for debtor companies seeking to invoke a court’s jurisdiction to restructure their debts via schemes of arrangement (schemes) to disclose material information in the explanatory statement. This information enables creditors to make an informed decision as to how to exercise their votes in creditors’ meetings. 

English schemes have been transplanted into common law jurisdictions in Asia, including Hong Kong and Singapore. However, due to the differences in the shareholding structures and the kinds of debts prevalent in restructurings in the UK as compared to those in Hong Kong and Singapore, this transplantation gives rise to the question of whether the English-based scheme process adequately addresses information asymmetry in the local context. Drawing from the experiences of Hong Kong and Singapore, our paper, supported by the Research Grants Council of the Hong Kong SAR, argues that there are three principal concerns in the current disclosure regimes: how debtors disclose the liquidation analysis or alternative to restructuring via schemes; how debtors disclose advisors’ fees; and the equality of provision of information in the scheme process. 

The key objective of mandatory disclosure for schemes parallels the objective of disclosure requirements for shareholder meetings under English corporate and securities laws:  reducing information asymmetry faced by the shareholders. Failure to make adequate disclosures to creditors can lead courts to refuse to approve the scheme. Mandatory information disclosure in the course of securing a vote on the restructuring plan also features prominently in Article 8 of the EU Directive on Preventive Restructuring Frameworks 2019/1023. 

However, there are specific risks in Hong Kong and Singapore that are either not present in the UK or not present to the same extent under traditional English schemes. First, shareholdings in listed companies in Hong Kong and Singapore are generally much more concentrated than in the UK. As a result, management’s interests are aligned with the controlling shareholders even when the company is “out of money.” In addition, schemes resolve all debts in Hong King and Singapore, rather than financial debts alone, as in the UK. Finally, retail investors have a significantly higher presence in debt instruments falling under the court’s jurisdiction. These different circumstances raise the question of whether the current disclosure regime sufficiently addresses risks arising from information asymmetry and provides the right incentives for debtors to disclose relevant and high-quality information for the creditors to make an informed decision when voting. 

While Hong Kong’s scheme framework has largely remained unchanged since its enactment, Singapore has amended its scheme framework to include several debtor-in-possession features of Chapter 11 of the US Bankruptcy Code (Chapter 11), such as the availability of super-priority, cross-class cramdowns, and pre-packs. However, Singapore’s disclosure requirements continue to be largely based on English case law.

Drawing from the US approach towards disclosure in Chapter 11, we argue that disclosure of sufficient information on the company’s valuation should be a central focus of the explanatory statement and that the restructuring support agreement (RSA) should be carefully reviewed. We also argue for an ex ante approach to disclosure statements under schemes of arrangement at the stage in which the court decides rather to grant permission to convene the scheme meetings. As both Hong Kong and Singapore have sophisticated and experienced judiciaries, earlier involvement of the courts may provide greater confidence in the process for investors by compelling the disclosure of key financial information. 

In our analysis of the practice of schemes, we reviewed approved schemes involving listed companies in Hong Kong and Singapore for the five-year period covering 2015-2019.  We obtained information on disclosures from announcements made by listed companies, explanatory statements from publicly available sources, stock exchange websites, and information agents for bond documentation. Where possible, we compare the disclosures to creditors with the separate disclosures to shareholders published in shareholder circulars. We conclude that the disclosure requirements under the traditional English scheme model are insufficient to adequately address risks to investors and creditors in Hong Kong and Singapore. In order to provide investors with greater confidence in the scheme process, additional disclosure in the explanatory statement regarding the value of the company, and ex ante review of explanatory statements and RSAs are needed. 

The full paper can be accessed here

A version of this post first appeared on the Oxford Business Law Blog.

Bankruptcy’s Equity Canon

By Jared Mayer (Law Clerk, Supreme Court of New Jersey)

Jared Mayer

The Bankruptcy Code constrains bankruptcy courts’ equitable powers, yet bankruptcy courts have often used those powers in ways that go beyond the Code’s text. This conflict creates tensions between various bankruptcy goals. The Code provides ex ante certainty and contains substantive policy choices, which equity threatens to compromise by allowing bankruptcy judges to override the text. Without equity, however, bankruptcy proceedings would provide parties with occasions to gain positional advantages in bankruptcy, thereby allowing them to unilaterally capture value at those other parties’ expense.

Drawing on insights from equity theory, this Essay identifies a role that equity can play to balance these interests. This Essay proposes an “equity canon” for bankruptcy courts to use when interpreting the Bankruptcy Code: judges should interpret unclear provisions by disregarding interpretations that would lead to inequitable outcomes. Equity theorists have illuminated equity’s role in combating opportunistic evasions of the law that cannot be identified and prevented ex ante. This is particularly important in bankruptcy. While bankruptcy proceedings are designed to maximize the estate’s value, parties nonetheless have incentives to capture value for themselves. Bankruptcy courts can use the equity canon to combat parties’ opportunistic exploitation of the Code while respecting the Code’s primacy.

The full Essay is available here.

Nothing herein reflects the views of the Supreme Court of New Jersey or the New Jersey Judiciary.

The Evolution of Corporate Rescue in Canada and the United States

By Jassmine Girgis (University of Calgary, Faculty of Law)

Jassmine Girgis

This chapter explores the evolution of corporate rescue in both Canada and the U.S. The timing and specific circumstances surrounding the legislation’s enactment were different in each country, but the underlying concepts and goals within the broader context of bankruptcy legislation were the same. Both countries had experienced the profound effects of business failure on directly impacted stakeholders, as well as on surrounding communities, and they recognized that saving companies would protect investments, preserve jobs, maintain the supplier and customer base, and prevent the wider impact of bankruptcy on society. To that end, both countries devised proceedings to restructure and rehabilitate financially distressed companies, allowing them to re-emerge with new debt or equity structures and continue operating as going concerns.

Historically, traditional restructurings – that is, proceedings in which the debtor company engages in lengthy negotiations with its creditors to restructure its debt obligations and business operations, all under the supervision of the court – were used extensively, dissolving unsuccessful companies while allowing others to emerge and continue operating. But these proceedings were slow, expensive, and cumbersome, and as changes in technology, firm assets, the economy and financial instruments modified the ways companies operated, and globalization altered their business methods and interactions with the community, a different process emerged. Rather than rescuing companies, this new process liquidated or merged them with other companies, and though traditional restructurings continued to occur, they have largely given way to sales or liquidations. Importantly, these emerging liquidation proceedings did not occur under bankruptcy or receivership regimes, but under the statutes that governed restructurings. They also occurred without meaningful consideration as to how this shift affects the public interest goals of the legislation.

The first part of this chapter discusses what happened: the history of these statutes, the reasons traditional restructurings emerged, and the eventual move to liquidations. The second part explores the three broad reasons liquidation plans replaced restructuring. First, an increase in secured debt left secured creditors in control of the financially distressed debtor corporations, and secured creditors typically prefer liquidation over restructuring. Second, the decline in the manufacturing and industrial era and growth of a service-oriented economy impacted firm assets; assets became less firm-specific and more fungible. Finally, increasingly complex financial instruments altered the composition of creditors; creditors at the table now include hedge funds and other non-traditional lenders, and they may be motivated by factors beyond saving the distressed company or maximizing its asset value.

The third part of this chapter addresses the consequences of using rescue legislation to liquidate companies. First, the governing legislation was not meant to be used in this way, and stakeholders in these expedited sales do not have the benefit of the procedural and substantive safeguards that arise in restructuring proceedings. Second, it is arguable that these liquidation proceedings do not fulfil the public policy goals of restructuring legislation. Finally, embedded within public policy is the concept of value-maximization, but what ‘value’ means and how it can be maximized, is not static, and may have different connotations under traditional restructurings than under liquidations.

The last part considers the most feasible way forward for each country: where does corporate rescue go from here? This section examines whether the bankruptcy forum should be abandoned in favour of non-bankruptcy legislation or private contracts, or whether the answer lies in improving the current legislative schemes. Although many do not want to see restructuring legislation overhauled, they do recognize that this legislation was enacted under different circumstances, in a different market, when corporations looked vastly different than they do today, and that to remain relevant, it must come to reflect today’s society and corporations. Doing so requires reconceptualizing how liquidation fits into the public policy goals of the statute and reassessing the concept of value to determine what it should encompass. 

The full chapter is available here.

Chapter 11’s Descent into Lawlessness

By Lynn M. LoPucki (Security Pacific Bank Distinguished Professor of Law, UCLA School of Law)

Lynn M. LoPucki

The bankruptcy courts that compete for big cases frequently ignore the Bankruptcy Code and Rules. This Article documents that lawlessness through a detailed examination of the court file in Belk, Inc.—a one-day Chapter 11—and a series of empirical studies.

Chapter 11’s lawlessness reached a new extreme in Belk. Belk filed in Houston on the evening of February 23, 2021. The court confirmed the plan at ten o’clock the next morning, and the parties consummated the plan that same afternoon. Almost none of Chapter 11’s procedural requirements were met. The court did not give creditors notice of the disclosure statement or plan confirmation hearings until after those hearings were held. Belk filed no list of creditors’ names and addresses, no schedules, no statement of financial affairs, and no monthly operating reports.  No creditors’ committee was appointed, no meeting of creditors was held, and none of the professionals filed fee applications. The ad hoc groups that negotiated the plan failed to file Rule 2019 disclosures. Because no schedules were filed, no proofs of claim were deemed filed. Only eighteen of Belk’s ninety-thousand creditors filed proofs of claim, and Belk apparently just made distributions to whomever Belk considered worthy. 

The procedural failures in Belk are just the tip of the iceberg.  The competing courts are ignoring impermissible retention bonuses, refusing to appoint mandatory examiners, failing to monitor venue or transfer cases, granting every request to reject collective bargaining agreements, and providing debtors with critical-vendor slush funds. The article is available here

Mass Exploitation

By Samir D. Parikh (Lewis & Clark Law School; Fulbright Schuman Scholar; Bloomberg Law; Fulbright Commission)

Samir D. Parikh

Modern mass tort defendants – including Johnson & Johnson, Purdue Pharma, USA Gymnastics, and Boy Scouts of America – have developed unprecedented techniques for resolving mass tort cases; innovation coupled with exploitation. Three weapons in this new arsenal are particularly noteworthy. Before a filing, divisive mergers allow corporate defendants to access bankruptcy on their terms. Once in bankruptcy, these mass restructuring debtors curate advantageous provisions in the Bankruptcy Code to craft their own ad hoc resolution mechanism implemented through plans of reorganization. This maneuver facilitates various questionable outcomes, including the third-party releases the Sackler family recently secured. Finally, in order to minimize its financial contribution to a victims’ settlement trust, a mass restructuring debtor can agree to convert its tainted business into a public benefit company after bankruptcy and devote future profits – no matter how speculative they may be – to victims.

The net effect of these legal innovations is difficult to assess because the intricacies are not fully understood. Debtors argue that these resolution devices provide accelerated and amplified distributions. And forum shopping has landed cases before accommodating jurists willing to tolerate unorthodoxy. The fear, however, is that mass tort victims are being exploited. The aggregation of these maneuvers may allow culpable parties to sequester funds outside of the bankruptcy court’s purview and then rely on statutory loopholes to suppress victim recoveries.  Mass restructuring debtors are also pursuing victim balkanization – an attempt to pit current victims against future victims in order to facilitate settlements that may actually create disparate treatment across victim classes.

This Essay is the first to identify and assess the new shadowed practices in mass restructuring cases, providing perspective on interdisciplinary dynamics that have eluded academics and policymakers. This is one of the most controversial legal issues in the country today, but there is scant scholarship exploring improvement of the flawed machinery. This Essay seeks to create a dialogue to explore whether a legislative or statutory response is necessary and what shape such a response could take.

The full article will be available at 170 U. Pa. L. Rev. Online ___ (forthcoming 2021) and can be accessed here.

Critical Vendor Order Insufficient to Protect Critical Vendors Against Preference Claims

By Nicholas A. Koffroth (Fox Rothschild)

Nicholas A. Koffroth

In Insys Liquidation Trust v. MeKesson Corporation (In re Insys Therapeutics, Inc.), No. 21-50176 (JTD), No. 21-50176, 2021 WL 3083325 (Bankr. D. Del. July 21, 2021), the United States Bankruptcy Court for the District of Delaware reminded practitioners to exercise caution when analyzing the scope of protections offered by critical vendor orders.  The order at issue in Insys Therapeutics provided that “[t]he Debtors are authorized, but not directed . . . to maintain and administer the Customer Programs” and that “[n]othing contained . . . in this Final Order is intended to be or shall be construed as . . . (c) a waiver of any claims or causes of action that may exist against any creditor or interest holder.”  These common provisions proved critical in the Court’s holding that “something more is required” to insulate critical vendors from preference liability.

In the opinion, the Court denied a motion to dismiss the complaint brought by a group of critical vendors for three reasons.  First, the Court held that preferential payments that occur before the entry of a critical vendor order cannot be protected by a subsequent authorization to pay outstanding prepetition claims unless specifically provided in the order.  Second, the permissive language of the critical vendor order did not support the vendors’ claim that the prepetition payments would necessarily have been authorized had they been made postpetition.  Third, the critical vendor order expressly preserved the estates’ claims against critical vendors.  Additionally, the Court analyzed and rejected application of the limited “critical vendor defense.”

The article discusses the Court’s holding in greater detail and offers practical considerations for practitioners. The full article is available here.

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