No Third-Party Releases? But What About Fraudulent Transfer Claims and Derivative Claims? (Purdue Pharma)

By: Donald L Swanson

In Purdue Pharma, the U.S. Supreme Court grants certiorari on this question:

“Whether the Bankruptcy Code authorizes a court to approve, as part of a plan of reorganization under Chapter 11 of the Bankruptcy Code, a release that extinguishes claims held by nondebtors against nondebtor third parties, without the claimants’ consent” (emphasis added).

Seems simple enough. But perhaps its not all that simple.

An Issue Within the Question

An issue, within the above-stated question, is this:

Are the fraudulent transfer claims and derivative claims being released in this case “held by nondebtors against nondebtor third parties”?

One of the amici briefs explains the issue within the question like this.

–Basic Bankruptcy Law

This is basic bankruptcy law:

under § 541, a bankruptcy petition filing creates an estate that includes all legal and equitable interests of the debtor in property existing on the filing date;
the Bankruptcy Code requires the bankruptcy trustee (or debtor-in-possession) to preserve and protect the estate, and to recover property of the estate—and in doing so, trustees often bring turnover, fraudulent transfer, and preference actions to recover property of the estate;
the U.S. Supreme Court has long recognized that “causes of action” brought by the trustee in the name of the debtor or estate are “property of the estate”; and
in seeking to recover property of the estate, the trustee, with approval of the bankruptcy court, can and often does settle such claims—with releases of the defendants.

To settle claims belonging to the bankruptcy estate, trustees must have the ability to resolve such claims completely by:

releasing defendants from further liability; and
preventing non-debtor parties (typically creditors) from asserting the same claims against the same defendants.

–Examples

Examples of claims against third parties held by the bankruptcy estate that can be settled by the bankruptcy trustee include the following.

First Example—Collecting Accounts Receivable. In a trustee’s action to collect on an account receivable, a creditor will have no plausible basis for a claim against the defendant, and the trustee can settle such claims—including the grant of a release to the defendant—with court approval.

Second Example—Recovering Fraudulent Transfers. By contrast to accounts receivable collections, fraudulent transfer claims are commonly held by, and can be asserted by, individual creditors outside bankruptcy. However, upon debtor’s bankruptcy filing, those same fraudulent transfer claims become property of the bankruptcy estate, at which time the Bankruptcy Code:

grants to the trustee the right to assert on behalf of the bankruptcy estate all state-law fraudulent transfer claims that were or could have been asserted by a creditor before the bankruptcy filing (see § 544(b)(1));
creates a federal fraudulent transfer cause of action in favor of the trustee (see § 548);
vests the power of recovering fraudulent transfers on behalf of all creditors squarely in the hands of the trustee—and when the trustee settles (with bankruptcy court approval) a fraudulent transfer claim on behalf of the estate and on behalf of all creditors, the creditors are bound by that settlement and have no right to further pursue their own non-bankruptcy claims to avoid the same transfer; and
authorizes bankruptcy courts, for purposes of assuring finality, to release the fraudulent transfer defendants and to bar creditors from any further action on the same fraudulent transfer claims against the same defendants—either as part of a chapter 11 plan or as a separate stand-alone settlement.

Third Example—Pursuing Derivative Claims. In a corporate derivative claim against directors and officers for breach of fiduciary duty:

creditors and/or shareholders may have a plausible basis for asserting the derivative claim outside bankruptcy; but
when the same derivative claim is asserted by a trustee in a bankruptcy case and then settled (including a release of the defendants), with court approval, the settlement is binding on all creditors and all shareholders; and
under the settlement, the only interest of creditors and shareholders in the settlement proceeds consists of the distribution they may be eligible to receive under the chapter 11 plan on account of their claim or equity interest.

Plan Settlement Rights & Powers Must Not be Deprived

The Bankruptcy Code expressly authorizes settlement of claims that qualify as property of the bankruptcy estate under a chapter 11 plan.

Sec. 1123(b)(3) says:

“a plan may . . . (3) provide for—(A) the settlement or adjustment of any claim or interest belonging to the debtor or to the estate.”

Accordingly, bankruptcy estates in all future cases must not be deprived, by the U.S. Supreme Court in this Purdue Pharma case, of the ability to release claims that are property of the estate.

And bankruptcy estates must not be deprived of the right and power to enforce such releases with injunctions against assertion of a released claim by a non-debtor party. This right and power must include claims where (but for bankruptcy) a non-debtor party has its own cause of action for the claim being released.

It is critical for our bankruptcy system that, in disposing of the present case, the U.S. Supreme Court not cast doubt on this essential settlement-and-release power!

Supreme Court Briefs

Multiple briefs, both of the parties and amici, are filed with the U.S. Supreme Court in the Purdue Pharma case.

A couple of the amici briefs focus heavily on the release of fraudulent transfer claims against insiders as improper third-party releases.

But neither of those briefs provides much of an explanation on how the foregoing analysis—about fraudulent transfer claims and derivative claims belonging to the debtor—applies to the Purdue Pharma plan.

One such amici brief emphasizes the release of $11 billion in fraudulent transfer claims as being improper without addressing the “property of the estate” argument set forth above. See this amici brief at 26-28.

Another focuses on the “abusive” nature of fraudulent transfers in this case—but fails to specify how or why the “property of the estate” argument above for fraudulent transfer claims does not apply. Such brief even makes this admission:

“There is no doubt that the estate could settle its fraudulent transfer claims.”

But then it adds:

“the direct claims of third parties against [non-debtor third parties] were not the estate’s to settle,” focusing on the “abusive” nature of the fraudulent transfers.

See this amici brief at 16-17 & 21. It’s unclear in such brief:

which claims the amici believe are “direct claims of third parties” that cannot be settled by the bankruptcy estate; or
how an “abusive” fraudulent transfer is different for release purposes from a garden-variety fraudulent transfer.

Limited Releases

The Purdue Pharma confirmed plan releases non-debtor third parties from claims held by the bankruptcy estate—presumably, that includes all fraudulent transfer claims and all derivative claims.

What more does the plan release? According to a limitation required by the Bankruptcy Court, the Purdue Pharma confirmed plan releases only the following types of claims against non-debtor third parties:

those “that directly affected the debtors’ estate and for which Purdue’s conduct was a legal cause, or a legally relevant factor, of any released cause of action” against the non-debtor third parties.

Such language is found in this linked Order of the Second Circuit Court of Appeals, quoting from and explaining the Bankruptcy Court’s Order confirming Purdue Pharma’s proposed plan (at 24a – 25a).

Conclusion

It will be interesting—and hugely important—to see what the U.S. Supreme Court does with the Purdue Pharma case.

Will it adopt a doctrinaire “never” for all third-party releases in bankruptcy?
Will it recognize, adopt and follow the release of fraudulent transfer and derivative claims analysis set forth above?
- Will it expand upon that analysis?
- Will it restrict that analysis?
Will it identify claims being released that are not fraudulent transfer claims or derivative claims or of a similar nature?

Time will tell.

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