By Jonathan Lipson (Temple University Beasley School of Law)
Jonathan Lipson
[Editor’s Note: The author represented, on a pro bono basis, an individual claimant in the bankruptcy of Purdue Pharma.]
In late 2022, counsel for opioid-maker Purdue Pharma posted an essay on the Harvard Bankruptcy Roundtable (HBRT), “Please Don’t Forget the Victims: Mass Torts, Third Party Releases and the U.S. Bankruptcy Code” (“Forget”).Forget largely restated arguments they made to the Second Circuit Court of Appeals in their bid to reinstate controversial nonconsensual nondebtor “releases” (NDRs) of collateral civil liability arising from the OxyContin-maker’s confessed drug-marketing crimes. HBRT asked me to respond to Forget because I was pro bono counsel to one of those they would have us remember: Peter Jackson, whose daughter Emily died after taking a single OxyContin in 2006.
While the sentiment to “remember the victims” is laudable, the substance of Forget renders its title a cruel irony. Forget says almost nothing about the victims of a public health crisis that has taken over half a million lives and in which Purdue Pharma, and its wealthy and secretive owners, the Sacklers, apparently played a singular role. Instead, Forget would honor survivors of this crisis through the use of legally dubious NDRs.
Forget conspicuously omits or distorts problems in the Purdue Pharma case and precedent on which its NDRs would rest. It ignores the fact that nondebtor “releases” and “settlements” are contractual in nature, and cannot be forced onto the unwilling; that over 80% of creditors cast no vote on Purdue Pharma’s plan, so there was hardly “overwhelming” support for it; and that the precedent on which they rely—historic mass tort and Supreme Court cases—are readily distinguishable from Purdue Pharma.
Forget would have us forget just how problematic Purdue Pharma—and its quest to insulate the Sackler family—has been, thereby seeking to induce a kind of “bankruptcy amnesia.”
By Steven O. Weise, Wai L. Choy, and Vincent Indelicato (Proskauer Rose LLP)
Steven O. WeiseWai L. ChoyVincent Indelicato
Note: This post is the fifth post in a series of posts on bankruptcies of cryptocurrency companies and the emerging issues they pose. Previous posts in the series include:
This series is being managed by the Bankruptcy Roundtable and Xiao Ma, SJD at Harvard Law School, xma [at] sjd [dot] law [dot] harvard [dot] edu.
Check the HLS Bankruptcy Roundtable periodically for additional contributing posts by academics and practitioners from institutions across the country.
***
The cryptocurrency market has experienced significant liquidity events, accelerating an industrywide sell-off and leaving the value of cryptocurrencies at historic lows—what many call a “crypto winter.” The idea that participants in the cryptocurrency industry, namely exchanges that operate platforms that allow users to transact in cryptocurrency, may resort to chapter 11 bankruptcy has created questions as to how such assets would be handled during a bankruptcy.
In “The Treatment of Cryptocurrency Assets in Bankruptcy,” Proskauer partners Steven O. Weise, Wai Choy, and Vincent Indelicato explore the question of whether crypto assets deposited by customers in a cryptocurrency exchange may be considered property of the bankruptcy estate and therefore not recoverable by the customer. While some commentators have suggested that crypto assets might be considered property of the bankruptcy estate, existing common law, current provisions of Uniform Commercial Code (UCC) Article 8, and proposed amendments to the UCC recognize that if the arrangement and relationship between the exchange and its customers is one that is characterized as “custodial,” the crypto assets held by the exchange should remain property of the customers and, hence, not subject to dilution by general unsecured claim holders. However, the analysis of when a custodial relationship exists will depend on the agreements and other facts of a particular relationship.
By Marshall S. Huebner and Marc J. Tobak (Davis Polk & Wardwell LLP)
Marshall S. HuebnerMarc J. Tobak
[Editor’s Note: The authors, along with other attorneys at Davis Polk & Wardwell LLP, represent Purdue Pharma L.P. and various affiliated debtors in connection with their ongoing bankruptcy proceedings.]
For decades, third party releases have been the cornerstone of mass tort bankruptcies that have resolved previously intractable litigation and provided meaningful compensation to victims who might well have otherwise recovered nothing. In cases such as Johns-Manville (asbestos), A.H. Robins (Dalkon Shield), Dow Corning (silicone breast implants), Mallinckrodt (opioids), and Boy Scouts of America, courts concluded, on a developed factual record informed by pre-bankruptcy litigation history, that value-maximizing settlements and plans of reorganization were viable only by providing settling parties paying into the estate third party releases of appropriate scope. The alternative to these broadly and deeply supported settlements, many in the billions of dollars, was years of costly and uncoordinated litigation in scores of fora and resulting in greatly diminished victim recoveries.
Critiques of third party releases often argue that these releases are in some way unfair to the parties subject to the release, or that third party release cases privilege monetary recoveries over nonmonetary goals. This article aims to address these issues and refocus the debate on the importance of third party releases in achieving and maximizing monetary and nonmonetary goals of victims in mass tort bankruptcies.
First, we canvass the overwhelming judicial consensus that the Bankruptcy Code (including sections 105 and 1123) authorizes third-party releases and channeling injunctions where important or essential to a value-maximizing reorganization, meet additional limiting tests, and are within the court’s jurisdiction. We highlight that a thorough examination of United States v. Energy Resources Co., 495 U.S. 545 (1990), demonstrates that the Supreme Court specifically affirmed the power of bankruptcy courts to confirm plans of reorganization that nonconsensually adjust rights and liabilities among third parties when such adjustments enable a successful reorganization.
Second, we examine how existing law—properly applied—appropriately limits third party releases to circumstances in which they maximize value for, and are broadly supported by, victims and other creditors. Proponents of a third party release plan must not only convince the court that it is objectively superior to the alternatives; in addition, the parties directly affected by the release must vote in favor of the plan by an “overwhelming” margin. Unsurprisingly, such plans are often crafted by creditors and debtors together, ensuring that they reflect victims’ monetary and nonmonetary goals.
Finally, we consider how mass tort resolutions would necessarily change if third party releases were to become unavailable. We note that recent legislative initiatives to categorically ban third party releases outside the asbestos context would make mass tort victims far worse off without achieving countervailing benefits. We recommend that legislative efforts directed at third party releases instead subject them to uniform procedures and standards. Such legislation would address valid critiques of overused third party releases while ensuring that they remain available, under uniform standards, in cases in which they are indispensable.
Note: This is the Harvard Law School Bankruptcy Roundtable’s last scheduled post for the fall of 2022. The BRT intends to resume posting around mid-January, 2023. The BRT wishes all its readers an enjoyable holiday season!
By Charles M. Oellermann and Mark G. Douglas (Jones Day)
Charles M. OellermannMark G. Douglas
Courts disagree whether a bankruptcy court, in exercising its broad equitable powers, has the authority to award appellate legal fees as a sanction for contempt. The U.S. Court of Appeals for the Second Circuit recently weighed in on this issue as an apparent matter of first impression. In Law Offices of Francis J. Reilly, Esq. v. Selene Finance, L.P. (In re DiBattista), 33 F.4th 698 (2d Cir. 2022), the Second Circuit held that a bankruptcy court erroneously concluded that it did not have the power to award attorney fees incurred on appeal by a debtor seeking to enforce a contempt order for violations of a bankruptcy discharge order.
The Second Circuit explained that it is well settled that a bankruptcy court, exercising its broad equitable powers under section 105(a), “may compensate a debtor for a creditor’s violation of [a] discharge order” entered under section 524(a). These provisions, the court wrote, which “‘bring with them the old soil that has long governed how courts enforce injunctions,’” authorize a court to impose civil contempt sanctions to coerce compliance with an injunction or to compensate a complainant for losses arising from noncompliance. “[I]n line with long-established practice,” the Ninth Circuit explained, a bankruptcy court’s contempt power includes the authority to compensate a party for damages arising from noncompliance with an injunction, “even if those losses take the form of appellate litigation fees.”
The Second Circuit rejected the argument that the “American Rule” precludes an award of appellate fees “absent explicit statutory authority.” According to the court, an exception to the American Rule has long been recognized that permits a court to award legal fees for willful disobedience of an order entered as part of a fine levied on a contemnor.
The Fifth Circuit held in October of this year in In re Ultra Petroleum Corp., 51 F.4th 138 (5th Cir. 2022) that a contractual make-whole provision in the debt instruments of certain unsecured creditors was unmatured interest under Section 502(b)(2). In this unusual case, where the debtor became solvent after filing for bankruptcy, the Fifth Circuit also held that the Solvent Debtor-Exception applied to claims for unmatured interest. The Fifth Circuit then determined that the Make-Whole Amount was a valid contractual claim and held that Ultra must pay the contractual Make-Whole Amount under the Solvent Debtor-Exception. Lastly, the Fifth Circuit held that an unimpaired creditor of a solvent debtor is entitled to interest at the bargained-for rate rather than the Federal Judgment Rate. In reaching this conclusion, the Fifth Circuit interpreted Section 726(a)(5)’s interest at the legal rate provision (relevant to a plan under Chapter 11 through Section 1129(a)(7)(A)) as a floor, rather than a ceiling, for interest payable by a solvent debtor.
Several law firms have now written memos summarizing this impactful decision. Weil summarizes the history of the Ultra Petroleum series of cases. Davis Polk suggests that the decision may have far-reaching consequences on the market use of make-whole provisions given the popularity of the Southern District of Texas as a forum for bankruptcy petitions. Proskauer notes that the Fifth Circuit’s decision addressed only the rights of an unsecured creditor with respect to a make-whole provision and suggests that Section 506(b) provides a legal basis for recovery of a make-whole provision by an oversecured creditor.
(This post was authored by Wesley Sheker, J.D. ’23.)
By Colin Davidson and Catherine Jun (Sheppard, Mullin, Richter & Hampton LLP)
Colin DavidsonCatherine Jun
Cannabis is now legal in 19 states and Washington D.C., driving the growth of a legal cannabis industry estimated to be valued at $33 billion this year—up 32% from 2021—and expected to reach $52 billion by 2026. This growth in the cannabis industry, of course, also means that operators and their investment partners face increased commercial risk, including insolvency. Cannabis companies have thus far been precluded from accessing federal bankruptcy protection—i.e., chapter 7 or chapter 11—largely due to the status of cannabis as an illegal substance under federal law. The legal framework used in the United States, where cannabis is illegal federally but has been legalized by many states, differs greatly from the framework in Canada. In Canada the federal Cannabis Act 2018 legalized cannabis nationwide, while the provinces maintain certain regulatory powers related to the distribution, sale and use of cannabis. This suggests that for cross-border operators one potential route to U.S. bankruptcy relief is for the company to first commence an insolvency proceeding in Canada and then seek recognition of that foreign proceeding in a U.S. bankruptcy court under chapter 15 of the Bankruptcy Code. We examine the viability of chapter 15 as an alternative avenue to the U.S. bankruptcy courts and the challenges that a cannabis company may face in an article originally published by Cannabis Business Executive.
By Mark Roe and William Organek (Harvard Law School)
Note: This is the seventh in a series of posts on the Texas Two-Step, the bankruptcy of LTL Management, and the future of mass tort bankruptcies. Check the HLS Bankruptcy Roundtable throughout the summer for additional contributing posts by academics from institutions across the country.
Earlier posts in this series can be found here (by Jin Lee and Amelia Ricketts), here (by Jonathan C. Lipson), here (by Jared A. Ellias), here (by Anthony Casey and Joshua Macey), here (by David Skeel), and here (by Ralph Brubaker).
***
Mark RoeWilliam Organek
Considerable attention is now being paid to the Texas Two-Step in bankruptcy. The Two-Step anticipates the movement of assets and liabilities from one corporate entity to another, via a divisive merger that splits the assets and liabilities of the original entity. After the movement of the assets and liabilities, the liabilities sit in one entity (often a subsidiary of a larger enterprise). Meanwhile, the liabilities are separated from many of the assets (in the most controversial form of the Two-Steps), which sit in another entity. The entity with the bulk of the liabilities then files for bankruptcy. The Two-Step is central to the Johnson & Johnson (“J&J”) bankruptcy of a subsidiary, aiming to separate the talc liabilities from J&J’s extensive assets.
When assets are transferred from a firm that is thereby rendered insolvent, or when the assets are transferred with actual intent to hinder, delay or defraud creditors, the transferred assets can, of course, be recovered by the transferring firm as a fraudulent transfer. Bankr. Code § 548. Similar transactions are regularly accomplished under corporate structures as spinoffs: the firm moves assets into a subsidiary, for example, and then “spins” off the subsidiary’s stock to the firm’s stockholders. After the spinoff the old stockholders own two companies, one with the assets (and possibly some of the liabilities of the just-created subsidiary) and the other with the liabilities (and any remaining assets) of the original company.
The Texas divisive merger statute creates a fraudulent transfer conundrum, because it says movements of assets pursuant to a divisive merger are not transfers. If there’s no transfer, there’s no fraudulent transfer liability, as there must first be a transfer for there to be liability.
If the bankruptcy process were ousted of power to control fraudulent transfers, then the debtor firm would have more freedom to move assets and liabilities in ways that would allow the firm to escape liability. No judge would get to the meaty issues (e.g., was the transferring firm insolvent? were the transfers done with intent to hinder, delay, or defraud creditors? is the bankrupt firm with the bulk of the liabilities an alter ego or successor of the original firm?) because there’d never have been a triggering transfer.
The Texas statute itself is clear on its face that there’s no transfer under Texas law:
When a merger takes effect . . . all rights, title and interests to all . . . property owned by each . . . party to the merger is allocated . . . as provided in the plan of merger without . . . any transfer or assignment having occurred . . .
Commentatorshavenoted that a Two-Stepping debtor might make such an argument. While it has not yet been explicitly raised in the LTL bankruptcy, the commentators anticipated correctly that such an argument was coming. In another pending Texas Two-Step bankruptcy, In re DBMP, the debtor made this argument at length. In an oral ruling1 delivered a little more than a week ago, on July 7, Judge Craig Whitley agreed with the key plain meaning premises of the Two-Step argument but ultimately rejected it as facilitating “wholesale fraud.”
The court began by accepting the debtor’s interpretation that, under a plain meaning reading of the Texas statute, no transfer occurred; and under a plain meaning reading of section 548 of the Bankruptcy Code, a transfer is a necessary predicate for a fraudulent transfer to have occurred. Hence, a plain meaning construction of section 548 and the Texas statute means no fraudulent transfer exposure.
Judge Whitley saw where such a plain meaning reading led, but refused to go there, rejecting the debtor’s conclusion. Going down the plain meaning route would, he said, lead to absurd results, leaving plaintiffs with “no recourse whatsoever.” And such a reading would contradict another provision of the Texas statute, which states that a divisive merger is not meant to “abridge any . . . rights of any creditor under existing law,” Tex. Bus. Orgs. Code § 10.901. Finally, Judge Whitley went deep: such a plain language reading of the Texas statute would run contrary to longstanding general principles of Anglo-American fraudulent transfer law.
Judge Whitley’s conclusion was in our view correct. But the conclusion can be reached more directly—by a plain meaning reading of the Bankruptcy Code.
The bankruptcy courts have already been instructed by Congress not to pay attention to the Texas statute, even when the state statute declares that an asset disposition in a divisive merger is not a transfer. True, considerable policy issues (e.g., supremacy of federal law, the extent to which state property and contract law is incorporated into the bankruptcy process) could well be brought to bear if the Bankruptcy Code were unclear here. But the most straightforward way to answer the question raised in DBMP comes from a parsimonious textual analysis of the Code.
Here’s the Bankruptcy Code’s two-step ouster of the Texas Two-Step:
Step 1:
The text of the fraudulent transfer statute, section 548, begins: “The trustee may avoid any transfer . . . of an interest of the debtor in property . . . ” (emphasis added). If we stop there, a basis might be had for examining state law for whether a transfer cognizable under the Bankruptcy Code has taken place. Property is, after all, transferred under state law.
But the Code does not say that state law governs whether a movement of property is a bankruptcy transfer. The Code itself defines the term “transfer” and does so independently of state laws’ appellations, leading to Step 2 of the ouster.
Step 2:
Section 101(54) defines what a “transfer” is for bankruptcy purposes, such as section 548 (governing fraudulent transfers). It states: “The term ‘transfer’ means . . . each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with (i) property; or (ii) an interest in property.”
The Code thereby instructs bankruptcy courts to conclude that a transfer has occurred for each “mode . . . of disposing of . . . property . . . .” A divisive merger under Texas law is surely a “mode . . . of disposing of . . . property. . . .” As a result, for bankruptcy purposes a Texas two-step is a transfer, whatever the Texas authorities decide to call it. And, therefore, the Texas Two-Step should have no import in bankruptcy for determining whether there’s been a transfer for bankruptcy purposes. Property has been disposed of. Thus, for Code purposes there is a “transfer.” The first statutory predicate to considering whether there has been a fraudulent transfer has been satisfied and the court could then go on to the other, meaty fraudulent transfer issues. The Texas Two-Step is a transfer because the Bankruptcy Code says it is.
While we reach an identical conclusion to that of Judge Whitley, and we do not fault his reasoning from the bench, our analytic path is better in the long run for bankruptcy decisionmaking. The court’s reliance upon the best way to interpret the potential contradictions of the Texas Business Organizations Code is a precarious foundation for the ruling. One could imagine another bankruptcy court, faced with the Texas statute’s contradictions (“it’s not a transfer” vs. “it’s not in derogation of any other right”), interpreting and concluding differently.2Another judge might not consider such a result as absurd as Judge Whitley and we do. And yet another bankruptcy court could feel compelled to certify questions to the Texas Supreme Court on how to interpret the Texas divisive merger statute and its impact.
***
The new mass tort bankruptcies present major issues of policy and statutory construction for which answers will not be assured and apparent. But the question of whether there is a transfer for bankruptcy purposes is clear. A divisive merger is a disposition of property and, hence, the Code says it’s a transfer, thereby triggering the opening prerequisite to there being a fraudulent transfer.
The Code says so. Plainly.
—
1: A recording of the hearing is embedded in the linked PDF, which PDF may need to be downloaded in order to access the recording; the relevant portion of the hearing begins around 20:15 in the recording.
2: See Curtis W. Huff, The New Texas Business Corporation Act Merger Provisions, 21 St. Mary’s L.J. 109, 122-25 (1989).
On June 28, 2021, in the chapter 11 cases of Paragon Offshore plc and certain of its affiliates (“Paragon” or the “Debtors”), the United States Bankruptcy Court for the District of Delaware denied the U.S. Trustee’s motion to compel payment of $250,000 in statutory fees assessed against litigation trust distributions. In its opinion, the Bankruptcy Court concluded that the U.S. Trustee had already collected all statutory fees due: first, when Paragon transferred its litigation claims to the litigation trust (the “Trust”) under its plan, and second, when the defendant in the Trust litigation, itself a chapter 11 debtor, later paid statutory fees in its own chapter 11 case based on, among other things, the cash settlement payment it made to the Trust. Finding the U.S. Trustee’s “attempt to double, or triple collect” the statutory fees “offensive,” the Bankruptcy Court held that the Trust’s payments of settlement proceeds to its beneficiaries were not “disbursements” made by or on behalf of the Debtors within the meaning of the U.S. Trustee fee statute, and as a result, that no such fees were payable.
A debtor can elect to either assume or reject an executory contract under section 365 of the Bankruptcy Code. Because the Bankruptcy Code does not define “executory”, courts have historically overwhelmingly applied the “Countryman” test – which asks whether the contract parties have remaining unperformed obligations such that the failure of either party to complete performance would constitute a material breach of the agreement – to determine if a contract is executory. In a recent decision, however, Judge Laura T. Swain, the district court judge presiding over the 2017 Puerto Rico Oversight, Management, and Economic Stability Act proceedings, declined to utilize the Countryman test and adopted the alternative “functional approach” to determine whether the agreements at issue were executory. The “functional approach” focuses on the post-petition benefit to the debtor from assumption or rejection of a contract instead of the pre-petition obligations under the contract. The decision is the latest among a string of recent cases that have relied on non-Countryman tests to determine whether a contract is executory, with the “functional approach” emerging as the prevailing alternative. Read the full article here.
By Stacey L. Corr-Irvine and Mark G. Douglas (Jones Day)
Stacey L. Corr-IrvineMark G. Douglas
It is generally well understood that an “oversecured” creditor is entitled to interest and, to the extent provided for under a loan agreement, related fees and charges as part of its secured claim in a bankruptcy case. Although section 506(b) of the Bankruptcy Code provides that fees, costs or charges allowed as part of a secured claim must be “reasonable,” the provision does not expressly impose any restrictions on the amount or nature of interest allowable as part of a secured claim. A Bankruptcy Appellate Panel for the Eighth Circuit recently considered whether a secured creditor is entitled to contractual default-rate interest under section 506(b).
In In re Family Pharmacy, Inc., 614 B.R. 58 (B.A.P. 8th Cir. 2020), the panel reversed a bankruptcy court’s order disallowing a secured creditor’s claim for interest at the default rate under the parties’ contract using a penalty-type analysis generally applied to liquidated damages provisions. According to the panel, such an analysis cannot be applied to default interest provisions. The panel also held that the bankruptcy court erred when it held that the default interest rate was unenforceable based on “equitable considerations.”
