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Mallinckrodt Pharmaceuticals Bankruptcy and Channeling Injunction Puzzle

posted by Adam Levitin

The outline of Mallinckrodt Pharmaceutical’s chapter 11 proposal (no filing yet) puzzles me.  Mallinckrodt is looking to put its US speciality generic subs in the chapter to slough off opioid liability, while keeping the parent and other subs out of bankruptcy.  The proposal would have Mallinckrodt fund a trust with $1.6 billion (face value) of cash payments and warrants for the purchase of 19.99% of Mallinckrodt parent’s common stock at a strike price that’s currently in the money.  The bankruptcy court would be asked to enter a channeling injunction along with third-party releases that would direct all opioid creditors to look solely to the trust for recovery, freeing Mallinckrodt parent and its speciality generic subs from the uncertainty opioid liability overhang.  

Here’s what puzzles me. The channeling injunction and third party releases being sought would be entered under section 105(a).  The only express channeling injunction and third party release procedure in the Bankruptcy Code, section 524(g), is solely for asbestos cases. While we’ve seen channeling injunctions and third party releases entered in a range of contexts beside asbestos under section 105, it seems problematic to me for a court to authorize either under section 105(a) on a less strict basis than is required under section 524(g). If a court could just go with judicially-crafted section 105(a) requirements in lieu of section 524(g), it would render section 524(g) requirements meaningless in the asbestos context.  
 
Specifically, what I have in mind is that section 524(g) requires that in order for a court to enter a channeling injunction, the trust be funded with a majority of the voting securities of either the debtor or its parent or co-debtor subsidiaries. This funding requirement is only about the channeling injunction. It is separate and distinct from third-party release requirements, although there is some overlap in that the contribution to the trust can come from the parent of the debtor, which might be eligible for a third-party release. 
 
Section 524(g) also permits third-party releases, meaning that the claims against the third-party are also channeled to the trust.  Such a third party release may be based, among other things, on “the third party’s ownership of a financial interest in the debtor,”  or “the third party’s involvement in the management of the debtor.”  Such a third-party release requires the court to find that it is “fair and equitable” in light of the third party’s contribution to the trust.  
 
Mallinckrodt parent’s contribution might well meet the requirements for a third-party release. But it doesn’t seem to satisfy the basic (and higher) 524(g) requirement for a channeling injunction in that it is neither surrendering a majority of its voting securities nor the majority of the voting securities of Mallinckrodt’s US specialty generic subs.
 
I haven't been able to find case law addressing whether a section 105(a) channeling injunction has the same procedural requirements as section 524(g); instead the 524(g) caselaw is focused on third-party releases. That said, I don’t think Dow and Corning had to give up a majority of their voting securities or a majority of the voting securities of Dow Corning as part of its channeling injunction. If not, however, how did they pull that off? Is it just that courts are willing to enter section 105(a) injunctions on a lesser basis than section 524(g)? If so, that seems to me to be on rather shaky legal grounds if an appeal ever got up to a circuit.
 
Please note that I am not suggesting that channeling injunctions are restricted to the asbestos context (that's another discussion), but simply that channeling injunctions outside the asbestos context need to meet the procedural requirements of 524(g) at a minimum. If it were otherwise, what prevents an asbestos case from seeking to use 105(a), rather than the more onerous section 524(g)?  
 
Perhaps there's an argument that Congress wanted more stringent requirements for asbestos cases, but I suspect that the legislative history does not support such an interpretation, given that when 524(g) was enacted there were no non-asbestos channeling injunctions of which I am aware. 

Comments

Perhaps there's an obvious policy reason you’ve overlooked which aptly explains the lack of requirements for filing under section 105(a).

The language in s.105(a), explicitly permits a bankruptcy court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”

This is clearly a catch-all, allowing the judiciary act equitably when public policy warrants it. This MDL situation is unprecedented, and it seems that this section allows for a common-sense approach, in unique situations.

Moreover, it’s also pretty clear that 524(g) is irrelevant since 524(g)(i)(I) explicitly provides that a prerequisite for 524(g)’s application is that it must be relating to a tort relating to asbestos.
The case re Globo Comunicacoes e Participacoes S.A., 317 B.R. 235 (S.D. N.Y. 2004) comes to mind.
In Globo, a New York district court held that a bankruptcy court erred in employing section 105(a) to dismiss a bankruptcy case where other provisions of the Bankruptcy Code provided definitive criteria for its dismissal.
The difference between Globo and Mallinckrodt is that in Mallinckrodt’s case, the Bankruptcy Code does NOT provide definitive criteria for its dismissal since 524(g) quite deliberately only applies to asbestos cases.
“Asbestos” has a plain and simple meaning. It would be ultra vires for a Judge to state that the legislature intended that “Asbestos” really also meant “Asbestos and Opioids”, or anything beyond “Asbestos”. For this reason, a judge could not rule that 524(g) should apply here or apply to any torts other than those specifically related to asbestos. The language, literally, could not be any clearer.
Finally, as a matter of common sense, which us lawyers often forget to include in the equation, public policy would also promote the courts using a fair and equitable approach, which was literally the exact purpose of the establishment of Section 1.05(a).

I look forward to your reply.

Hi MS.

(1) There's a definite split of views on how far 105(a) reaches, but it's pretty clear that section 105(a) is not free-standing authority to do anything that the court thinks furthers public policy. My own 2¢ is that it is overused, as it is just the bankruptcy version of the All Writs statute for district courts. At the very least, however, I think Collier's has it right when it says:

>>Section 105 uses the term “provisions” and not the term “purposes” in describing the bankruptcy court’s power to effect the mandate of the Bankruptcy Code. The statutory language thus suggests that an exercise of section 105 power be tied to another Bankruptcy Code section and not merely to a general bankruptcy concept or objective."<<

There's not an obvious statutory hook in the Code for section 105 to be the basis of a channeling injunction, much less a third party release.

(2) I don't think 524(g) is irrelevant. Yes, it formally applies only to asbestos; I am not suggesting that it actually applies to opioids. Instead, I am suggesting that it indicates a minimum standard for channeling injunctions and third party releases in general. The 3rd Circuit's Combustion Engineering decision from 2004 (which I overlooked) is pretty on point. Debtor Cmbustion Engineering was an asbestos case that tried to do a non-debtor release using 105(a), rather than 524(g). The 3rd Circuit said that wasn't allowed. A narrow takeaway from Combustion Engineering is that all asbestos cases have to run through 524(g). But it can also be read to suggest that channeling injunctions and third party releases have to comply with the minimum standards of 524(g) even in non-asbestos cases. After all, there is nothing about the specifics of the 524(g) channeling injunction and third party release provisions that particularly relates to asbestos. The same policy concerns it addresses arise with lots of mass torts.

(3) I think the history of channeling injunctions is pretty important for the statutory interpretation question. The first such injunction of which I am aware was in Johns Mansville. It was an asbestos case, and it was done under 105(a). Then Congress got in the act by passing section 524(g), which was modeled on the Johns Mansville deal. When Congress enacted 524(g) it simply did not contemplate channeling injunctions in any context other than asbestos. That's why I think it's odd to read 524(g) as prescribing a higher standard for asbestos cases than for other mass tort cases. Put another way "asbestos" in 524(g) is not a limitation on the procedural principles, and it's odd to think that Congress wanted one procedure for asbestos and was ok with whatever the courts came up with for all other mass torts.

Even more on point than the Globo case is: re Combustion Engineering, Inc., 391 F.3d 190, 236-37, 43 Bankr. Ct. Dec. (CRR) 271, Bankr. L. Rep. (CCH) P 80206 (3d Cir. 2004), as amended, (Feb. 23, 2005).

In this case: "The Plan proponents cite to several cases where § 105(a) injunctions in favor of non-debtors were approved, including In re Dow Corning Corp. (Dow Corning IV), 280 F.3d 648, 656 (6th Cir. 2002); In re Drexel Burnham Lambert Group, Inc., 960 F.2d 285, 292 (2d Cir. 1992); and In re A.H. Robins Co., 880 F.2d 694, 700-02 (4th Cir. 1989). But these cases are readily distinguishable, given that none involved either asbestos or § 524(g). Whatever may be the limits of § 105(a) in other contexts, we hold only that § 105(a) cannot be used to achieve a result not contemplated by the more specific provisions of § 524(g), which is the means Congress prescribed for channeling the asbestos liability of a non-debtor.


Notice how the court distinguished the use of "Asbestos"

Yes, Combustion Engineering is limited to asbestos because that was what was before the court. But it doesn't say that the 524(g) requirements do not apply in other contexts. It just didn't address that question.

Imagine that 524(g) only said "blue cars" and before 524(g) channeling injunctions had only been used in blue car bankruptcies. It's hard to see why at the principles of 524(g) would be limited only to blue car bankruptcies, and not cover red car bankruptcies as well. Yet that's the argument you're making, as you're not arguing that there's anything fundamentally different about asbestos from other mass tort bankruptcies, just that 524(g) is only about asbestos and cannot therefore be applied by analogy.

Adam:

Thank you for the prompt reply.

1. That 524(g)'s application should be limited to asbestos torts, is not my argument; but rather, its what the courts in Combustion Engineering stated (albeit, in dictum) as the reason for its rejection of the Plan proponent's citation of various cases.

The Plan proponents cite to several cases where § 105(a) injunctions in favor of non-debtors were approved [...] But these cases are readily distinguishable, given that none involved either asbestos or § 524(g)"

1(a). In Drexel para 293 (cited above): the court provided as follows:

"In bankruptcy cases, a court may enjoin a creditor from suing a third party, provided the injunction plays an important part in the debtor's reorganization plan. [...] The Settlement Agreement is unquestionably an essential element of Drexel's ultimate reorganization. In turn, the injunction is a key component of the Settlement Agreement. As the district court noted, the injunction limits the number of lawsuits that may be brought against Drexel's former directors and officers. This enables the directors and officers to settle these suits without fear that future suits will be filed. Without the injunction, the directors and officers would be less likely to settle. Thus, we hold that the district court did not abuse its discretion in approving the injunction."

While there are no specific references to 524(g) or 105(a), the policy and rationale of the Court in Drexel seems perfectly in line with the facts in Mallinckrodt.

3. With regards to your "blue car" analogy, I think there is a strong argument that if Legislature went out of its way to specifically identify blue cars, it most definitely did not mean "red cars". Whether legislature had a good reason to solely identify "blue cars" is beyond the court's jurisdiction to consider. Notwithstanding, I concede that there is a superior argument of asbestos having broader application.

4. I'm curious your prediction of how a court will resolve this. If a court requires use of 524(g), is there any way a resemblance of the current frame work would still be available?

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