Purdue Pharma, the maker of OxyContin, filed for bankruptcy in 2019 to resolve thousands of opioid-related lawsuits. Two years after filing, a reorganization plan was confirmed: in exchange for a financial contribution of several billion dollars by the Sackler family and relinquishment of their ownership in Purdue, the family would be released from all civil liability associated with their ownership and control of Purdue. Individual claimants, state attorneys general, the United States Trustee, the Department of Justice, Congress, academics, and others criticized the settlement as an abuse of the bankruptcy system. These parties contended that granting this immunity over their objections–known as a third-party release–was an unfair remedy. They stated that such a plan would reduce creditors’ financial recoveries and make it more difficult to achieve their goals of learning about Purdue’s role in the opioid crisis and preventing future corporate malfeasance. Instead, if the Sacklers were to receive immunity, critics suggested that the Sacklers should be required to file for bankruptcy. A Sackler bankruptcy filing, they claimed, would increase creditor recoveries and ensure that creditors’ nonmonetary goals would be met.
This Article argues that these criticisms rely on a deeply problematic assumption: on closer inspection, it is not at all clear that a Sackler bankruptcy filing would result in better monetary or nonmonetary outcomes for creditors, and could actually detract from these goals.
From a monetary perspective, demands for a Sackler bankruptcy filing overlook the factual complexity that this would entail, and the corresponding weaknesses in remedies available to creditors under bankruptcy law. The Sacklers engaged in sophisticated asset protection strategies that limited creditors’ financial recoveries by spreading ownership and control of Purdue, as well as their other holdings, across dozens of domestic and international spendthrift trusts to benefit scores of family members. Demands for a Sackler bankruptcy filing ignore collections issues, the illiquidity of their holdings, the discounts that might be applied to recoveries of minority interests, and the limitations on creditors’ fraudulent transfer remedies. To overcome these problems and maximize financial recoveries, the parties agreed to a “de facto substantive consolidation”: a consensual dissolution of the legal barriers separating the assets of individual members of the Sackler family, their trusts, and Purdue. This ad hoc solution, while effective, depended on Sackler acquiescence.
Achieving creditors’ nonmonetary goals, such as broader disclosure, restrictions on the opioid businesses of Purdue and the Sacklers, and limitations on Sackler charitable donations, would probably have been made more difficult by a Sackler bankruptcy filing. A bankruptcy filing likely would have pitted family members against one another, making disclosure or other consensual resolutions more difficult. Courts also have limited ability to force debtors to divest assets or refrain from participating in business or charitable endeavors. Instead, the Sacklers agreed to these undertakings because it was clear from the commencement of the case that the availability of a third-party release was contingent upon their cooperation. Only by being able to offer what the Sacklers wanted–civil immunity–could creditors and the court cajole the Sacklers into agreement.
This Article demonstrates the institutional limits faced by the bankruptcy system in addressing certain kinds of monetary harms and nonmonetary objectives. It ends by proposing reforms to fraudulent transfer law that would close the international spendthrift trust loophole that was so critical to the strategy pursued by the Sacklers to limit creditors’ monetary recoveries. It also argues that the price of achieving creditors’ nonmonetary goals can be reduced in future mass tort bankruptcy cases by mandating expanded disclosure by parties seeking third-party releases, more consistent appointment of trustees to manage the debtor in mass tort bankruptcies, and appointment of examiners to uncover information about the causes of a mass tort.
The full article is available here. Comments to the author are welcomed: worganek [at] law [dot] harvard [dot] edu.
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).
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:
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.
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).