Should Chapter 11 Protect the Sacklers?

My colleague, Ralph Brubaker, and Gerald Posner have a New York Times op-ed assailing how the Sacklers are using Purdue Pharma's chapter 11 to shield themselves from personal liability. The bankruptcy world knows this tactic under the labels of third-party or nondebtor releases.

When they first appeared on the scene, third-party releases seemed like another example of the pragmatic problem-solving that the bankruptcy system excels at doing. Parties contribute money to the pot that goes to pay creditors, often victims of some tort. That money increases the amount that victims receive without having to suffer the time, expense, and uncertainty of having to file lawsuits. The release incentivizes the released parties to contribute in the first place. No contribution, no release.

Like many good ideas in the bankruptcy system, third-party releases were supposed to be the rare case but have become commonplace in chapter 11 practice. As Brubaker and Posner point out, if third parties like the Sacklers need protection from tort liability associated with Purdue Pharma, they can always file bankruptcy themselves. They want the protection of the bankruptcy court without subjecting their own assets and affairs to the scrutiny of the bankruptcy court. At the least, that needs to change. 

Comments

[Eric B Rasmusen]

In general, the question for Chapter 11 is whether the creditors are better off if the Court keeps the corporation going without reorganization than if they liquidate it or sell it at auction. Whether it helps the equityholders shouldn't matter, though incidentally they will benefit.
So I should think the fact that the Sacklers are evil drugdealers shouldn't be relevant anyway, if Chapter 11 is what's best for creditors---where creditors include present and future tort claimants.
On the other hand, if some of the creditors have, like the Sacklers, benefited from immoral and unlawful activities, maybe that should be relevant. For instance, suppose a bank lent Purdue Pharma a billion dollars at high interest rates to help them get people addicted to their pills through fraud. Would it be legitimate for the bankruptcy court to take that into account in its decisions?

[FJP]

The suggestion that nondebtor releases of parties like the Sacklers should be approved if the creditors are "better off" than they would be without the releases begs two questions.

The first is "better off compared to what?" I would argue the answer should NOT be compared to Chapter 7, but rather to a Chapter 11 plan outcome without the releases. Making Chapter 7 the standard basically validates a hostage strategy, threatening to metaphorically burn the estate down, regardless of the consequences to creditors, unless the shareholders get their releases.

The second question is "how much better off is enough?" One dollar? A thousand? Ten million? In all of these release disputes, the shareholders argue paradoxically that all claims against them are meritless and they have absolutely no personal liability under any circumstance, but the releases are absolutely necessary for them to contribute a dime. The tendency of bankruptcy courts to gravitate toward the Rule 9019 "lowest point in the range of reasonableness" standard, as well as the tendency of bankruptcy courts to be reluctant to stand up to the bluff of "if you don't give us exactly what we want right now on a short notice basis, then everything is off and the whole case crumbles", combine to create a situation where definitely the perception, and in at least some cases the reality, is that it's a game of seeing how little the shareholders can get away with kicking in.

Conversely, I'd argue that a defensible case for approving releases exists if the court conducts a genuinely fair fairness hearing, leading to a preponderance-of-the-evidence determination, not skewed by any presumptions, that the shareholders' contribution reflects an assessment of the likely outcome of pursuing the claims against them -- as to liability, compensatory damages, AND punitive damages (which would require at least some disclosure of the shareholders' personal assets).

[Adam Levitin]

Worth pointing out that no one has filed an examiner motion in the case, even though it's hard to think of a case that more needs one.