Purdue's Poison Pill and the Broken Chapter 11 System

Jonathan Lipson and Gerald Posner have an important op-ed about the Purdue bankruptcy in the NYT and how the DOJ settlement with Purdue is likely to benefit the Sacklers. What's going on in Purdue is troubling, but not just for its own facts. Purdue illustrates a fundamental breakdown of the checks and balances in the corporate bankruptcy system.

The basic problem is that debtors can pick their judges in a system that precludes any meaningful appellate review. That lets debtors like Purdue push through incredibly inappropriate provisions if they can get a single non-Article III judge of their choice to sign off. This happening in as high-profile and important a case as Purdue should be an alarm bell that things have gone off the rails in large chapter 11 practice. Where Purdue goes, chapter 11 practice in other cases will surely follow. 

Purdue is perhaps the most extreme illustration of the confluence of three trends in bankruptcy each of which is problematic on its own, but which in combination are corrosive to the fundamental legitimacy of the bankruptcy court system.  

• First, there is a problem of debtors attempting to push ever more aggressive and coercive restructuring plans.
• Second, there is the lack of effective appellate review of many critical bankruptcy issues.
• And third, there is the problem of forum shopping, particularly its newest incarnation, which is about shopping for individual judges, not just judicial districts.

Put together this means that debtor are picking their judge, knowing that certain judges will be more permissive of their aggressive restructuring maneuvers and that there will never be any meaningful appellate review of the judges, who are free to disregard even clear Supreme Court decisions. A single judge of the debtor's choosing is effectively the only check on what the debtor can do in chapter 11. That is a broken legal system.  

Problem 1: Coercive Restructurings

The idea of debtors attempting coercive restructuring plans is nothing new, and standing on its own is not a problem. I remember wargaming a death trap plan in a case fifteen years ago, although we were too risk averse to actually propose that plan. But debtors are always looking for ways to be more aggressive with their plans, and DIP financing agreements, hurry-up asset sales, restructuring support agreements, and rights offerings provide increasingly used tools for pushing through restructurings that end-run a range of protections, including the absolute priority rule. As long as there is a meaningful judicial check on debtor (and creditor) overreach, the fact that some parties play hardball isn't itself a systemic problem. 

Purdue's Sub Rosa Plan and Poison Pill 

Purdue, however, takes the coercive restructuring approach to a previous unseen level, namely by including a "poison pill" in a settlement that effectively precludes any restructuring other than the one envisioned by Purdue. The operation of the poison pill are complicated, and I am simplifying things a bit, but here's the basic idea. Purdue entered into a settlement with the Department of Justice for its civil liability (False Claims Act stuff, etc.):  

• The settlement fixed the amount of the DOJ's previously disputed claim. That's fine and normal.
• The settlement also provided for the separate classification of the DOJ claim and the treatment of the DOJ claim (a "super priority administrative expense claim"--whatever that chimera is). To my mind that's intruding on plan territory, but it's not enough to get my dander up.
• The settlement also provides that Purdue will restructure itself into a "public benefit corporation" or the like, but that under no circumstance may DOJ be given the stock in this PBC entity. Again, getting more aggressive—the settlement is dictating what looks like a plan outcome and is not just dictating the treatment of DOJ, but also the treatment of other creditors (who must be separately classified and some of whom must get directly or indirect the residual interest in the PBC). In other words, the settlement functions as a sub rosa plan. 
• The settlement also provides that DOJ can walk away from the settlement at any time for any reason, including the failure to restructure as a PBC. That alone isn't a big deal. 

But then there's the kicker: the settlement provides that if DOJ walks away, its claim will not go back to its prior disputed, unliquidated status, but will instead revert to its nominal massive amount of some $18 billion—far more than the value of Purdue. What's more, that claim won't even really be a claim, but will be civil asset forfeiture rights. That's super-duper priority, as civil asset forfeiture results in a forfeiture of title to assets to the US government upon the commission of the wrong-doing. (The assets subject to forfeiture aren't really even part of the Purdue estate!) The effect of DOJ walking away from the settlement, then, would be that DOJ would get all of Purdue's assets, which would go into the US Treasury's general fund, rather than being available for states and local governments and opioid victims, who could use the funds for opioid abatement. 

That's the "poison pill" provision—if DOJ isn't happy, it walks away and leaves no value for anyone else. That meant that if the settlement were approved, the only way Purdue's other creditors could ever see a distribution would be if they played along with what DOJ and Purdue want. A sub rosa plan in a settlement is aggressive enough, but the additional "poison pill" was an incredibly coercive provision that I have never seen in a bankruptcy previously and which no court to my knowledge has ever previously blessed, much less in a case like this one. Purdue's taking hardball to a new level. 

To recap: Purdue proposed a sub rosa plan embedded in a pre-plan settlement, and that sub rosa plan is locked in through a "poison pill." It's impossible (I think) to square this with the Supreme Court's recent ruling in Czyzewski v. Jevic that there is no end-running plan protections. And all of this got decided through hurry-up motion practice, without notice to most of Purdue's thousands of creditors. 

So what's the big deal here? Doesn't everyone come out ahead if Purdue restructures as a PBC and money goes to opioid abatement rather than the US Treasury's general fund? Not quite. 

First, restructuring Purdue as a PBC precludes other alternative restructurings, such as a sale followed by a liquidation. 

Second, many of Purdue's creditors do not want to own—directly or indirectly—a public benefit corporation. These are opioid victims. They do not want any continued association with an opioid manufacturer, which they see as a public burden corporation. 

Third—and this is the key—the poison pill gives Purdue the ability to settle its fraudulent transfer claims with the Sacklers for a relatively low value and for Purdue to confirm a plan with nondebtor releases for the Sacklers. That means that Sacklers would be able to avoid their civil liability to the states and individual opioid creditors for a relatively low cost and without having to have gone through bankruptcy themselves. The Sacklers will be able to walk away from Purdue keeping most of their allegedly ill-gotten gains without having had to open the disclosure kimono that bankruptcy requires. Not only does that mean that opioid victims might not get as much of the abatement funds as they should get because the full extent of the Sackler's assets and ability to pay might not be known, but it also means that we will never know the full story about what went on at Purdue, and that matters because this sort of mass tort bankruptcy is as much about dignitary interests as it is about money. Without the poison pill, creditors might well have voted against a plan that included releases for the Sacklers. With the poison pill, they are unlikely to vote against the plan. 

While Purdue is proposing creating a document archive to be publicly available after the bankruptcy, there are real questions about what will be included in that archive, as DOJ will have to sign off on what is released, privileged documents cannot be included, and there may be questions of document ownership—and most importantly no one will know at the time of voting on a plan. If you are concerned about dignitary interests, this is a problem.  

It's outrageous that the bankruptcy court would approve this sort of settlement provision outside of a plan (and there was no good reason that the court had to rule now; it could easily have waited and considered the settlement as part of plan confirmation). The bankruptcy court seems to think that the PBC structure contemplated is good for society. That really shouldn't be a judicial concern here—courts are supposed to be referees, not conductors—but this sort of coercive plan provision—whether in a settlement or a plan—should be absolute off limits. This shouldn't have been a close call. 

[I don't generally jump in as an amicus when I think something is a close call except to flag a spillover effect concern for a court. Here, I thought the deal was so outrageous that an amicus brief was necessary. If you want a more detailed take, see the amicus brief that Jonathan Lipson and I filed (joined by a number of other bankruptcy professors, including some Slipsters) in opposition to the DOJ settlement with Purdue. The treatment of our motion for admission of the brief was the most bizarre amicus experience I have had and reinforces increases my concerns about the case.]

But why would DOJ go along with a deal that lets the Sacklers "get away with it"?  

DOJ wanted a deal done for political reasons and has now effectively become prisoner of its own deal. If DOJ doesn't like a plan that includes non-debtor releases, DOJ can walk away, but then it scuttles not just the deal it has cut in the bankruptcy, but also its criminal plea deal with Purdue, as Purdue's sentencing is delayed until after plan confirmation and that deal has a walkaway clause for Purdue. DOJ is too invested in the deal to walkaway over a nondebtor release for the Sacklers as long as the Sacklers contribute a few billion to the plan in exchange for their release. Now that DOJ has settled its own stake, it doesn't care about the marginal dollar or disclosure for other creditors. And that lets Purdue use the threat of a DOJ walkaway as leverage against its other creditors. 

Problem 2: Appellate Rights Are Often Illusory in Bankruptcy 

General Problems with Appellate Review in Bankruptcy

Now here's the real problem. It might be impossible to do anything about this perversion of bankruptcy law. Bankruptcy has a bunch of provisions that preclude effective appellate review. The Bankruptcy Code itself has provisions precluding reversal on appeal of sales (363(m)) and financings (364(e)). Valuation opinions are extremely difficult to appeal as they are factual determinations by the trial court-appellate courts aren't going to second guess evaluation of expert demeanor or get into discounted cash flow analysis. Relatedly, the fact that a bankruptcy court's ruling might not be an appealable "final order" also delays and moots appeal of many other issues. By the time an appellate court hears an appeal in bankruptcy so much time has passed that parties are often likely to settle because time is money to them. 

Equitable Mootness

I'm not sure if the order approving the settlement is a final order and therefore appealable. But even if it is, it is unlikely that an appeal would be heard prior to a plan being approved and becoming effective. At that point, equitable mootness—a doctrine that has been warmly embraced by the Second Circuit—will likely prevent a hearing of the appeal on the merits. Equitable mootness is the "Humpty Dumpty" doctrine of bankruptcy law—once money starts flowing under a plan, courts are reluctant to reverse anything central to the plan because it's impossible to put Humpty-Dumpty back together again; there have been reliance interests on the plan. 

Equitable mootness is controversial, but it's a robust doctrine in the Second Circuit. That leaves open only the possibility of the Supreme Court granting certiorari to hear an appeal about equitable mootness after the Second Circuit denies the appeal on equitable mootness grounds. Even if objectors were to prevail before SCOTUS (and the more time lapses, the stronger the equitable mootness case becomes), they would still have to take up the appeal on the substance of the plan itself separately, as lower courts are unlikely to have ruled on it because they will have disposed of the case on equitable mootness grounds. It could be years before this is all resolved, which is exactly the point. Attrition often results in settlement. Whatever formal rights of appeal exist, they are functionally next to worthless.  

This should be incredibly concerning to everyone who is concerned about the integrity of the bankruptcy system because it interfaces with a separate problem in bankruptcy:  forum shopping and judge shopping.

Problem 3: Forum Shopping and Judge Shopping  

Bankruptcy venue rules are quite permissive and allow a good deal of forum shopping.  This is hardly a new problem.  But in recent years we have been seeing a intra-district judge shopping phenomenon that makes it much worse. A number of districts have local rules that assign all complex cases to a single  judge or pair of judges. Additionally, some districts, like SDNY, have local rules that assign all cases with debtors with particular addresses to a particular judge. The WSJ has done some great reporting on how this has been abused by debtors renting nominal office space in White Plains, NY, in order to get their cases before Judge Robert Drain, to whom White Plains cases are assigned (a second judge now also gets White Plains cases because so many debtors took advantage of this provision). Purdue is one of those firms that maneuvered its case to be before Judge Drain—Purdue had no legitimate claim to a White Plains venue under the Bankruptcy SDNY local rules—but venue isn't jurisdictional, and on its own the venue issue is often regarded as no biggie in the bankruptcy world. 

I do not know why Purdue wanted its case before Judge Drain. There are a bunch of perfectly good reasons why a debtor might want a particular judge—case management skill, temperament, experience of the judge, experience with the judge—as well as some more troubling ones—precedents from the judge, temperament, case management style, willingness to approve fees, a tendency to favor debtors, etc.

Purdue's actual motivations are irrelevant, however. The appearance of possible impropriety is concern enough. The standard for the judicial system should be a "punctilio of an honor the most sensitive". When debtors can pick their judges in a system that effectively precludes meaningful appellate review, the integrity of the entire system becomes suspect. That this can happen in one of the most important bankruptcy cases ever from a social policy perspective should be a call for a reform of the bankruptcy venue and appellate system. 

But surely if a judge were doing really inappropriate things, there are remedies are there not?  Couldn't creditors seek mandamus from the district court to withdraw the reference to the bankruptcy court or couldn't they file a disciplinary complaint against a judge? In theory yes, but doing so is professional suicide for any attorney. Given the venue rules, an attorney with a large case bankruptcy practice has a high likelihood of ending up back before one of the handful of judges who are getting most of the large cases (Drain, Isgur, Jones, Huennekens). Do you want to hire the attorney who just pissed off the judge? Repeat players aren't going to make waves. Instead, they are going to tolerate bad judicial behavior, like routine ex parte communications, that would never be tolerated in federal district court.

[Notice that this problem is really more of an issue for creditors' counsel than for debtors' counsel. After an exasperated Delaware judge dropped an F-bomb on Kirkland & Ellis for pulling a sharp move against a pro se creditor, K&E took its toys and left the sandbox. K&E stopped filing cases in Delaware and started filing in Richmond and Houston. Creditors can't do that, as they don't choose the venue.]

I do not lightly call the Chapter 11 system broken. It is a system that works incredibly well in many regards. And I do not mean this post as an indictment of the bankruptcy bench in any way. The bankruptcy bench is generally of extremely high quality. But the bankruptcy works well because it is a procedural mechanism for balancing debtor and creditor rights. There are certainly judges who get overly invested in steering "their cases" to a particular outcome (the "Eastern Airlines" problem—the judge refused for far too long to pull the plug on a zombie debtor). But the system is able to handle the occasional over-invested judge as long as cases are more or less randomly assigned and there is effective appellate review.

Random case assignment and appellate review are essential checks and balances for the bankruptcy system. The whole balance of the system is upset when forum shopping and lack of effective appellate review enable debtors to pick judges and evade review of overreaching maneuvers.

So what can be done. In the first instance, the bankruptcy courts can fix part of the problem by adopting random intra-district judge assignment rules for all non-SBRA chapter 11 cases. It's not a big burden for a large Westchester County-based company to go to the Bowling Green courthouse or vice-versa. This means that complex cases should all be randomly assigned, rather than directed to particular judges. Second, there's still the more general problem of district shopping, which requires a legislative fix. And third, and perhaps more important than venue reform legislation is the need to reform the bankruptcy appellate process so that appeals can be taken more easily and quickly. At the very least, there should be expedited appellate review (without a supersedeas bond posting) for things like nondebtor releases in mass tort cases. 

Comments

[vsjb]

"It's not a big burden for a large Westchester County-based company to go to the Bowling Green courthouse"

lol.

[BKA]

From my experience, a major challenge with appeals in a Chapter 11 case is that they often take a year or more to obtain a ruling. A Chapter 11 reorganization cannot be put on hold for year waiting for the outcome of an appeal.