In the unfolding legal drama between Purdue Pharma, the Sackler family, and the victims of the opioid crisis, the stakes go beyond the billions of dollars in victim compensation. The case will establish important precedent when it comes to corporate responsibility, public perception of injustice, and the extent of bankruptcy courts’ powers. At the heart of this debate lies the contentious legal principle of "nonconsensual third-party releases," a concept now under review by the Supreme Court. Professor Edward Morrison of Columbia Law School elucidates the key issues at stake and discusses the unique authority that bankruptcy courts have to release liability more expansively than other judicial bodies.
The ability of bankruptcy courts to grant nonconsensual third-party releases to entities that have not filed for bankruptcy themselves remains a subject of considerable legal debate that varies across jurisdictions. As Prof. Morrison notes, the U.S. Bankruptcy Code neither explicitly authorizes nor prohibits such releases, except in the context of asbestos liability, which is explicitly addressed in the code. Consequently this vagueness has led courts to interpret the code in disparate ways.
In certain jurisdictions, bankruptcy courts have relied on their broad powers under Section 105(a) of the Bankruptcy Code, taking measures they deem "necessary and appropriate." These courts frequently employ a six or seven-part test to gauge whether such releases are fair, appropriate, and essential to the debtor's reorganization plan. Additionally, these courts regularly assess whether affected parties have had the opportunity to object and if those who would be bound by the release are "adequately represented" during proceedings.
Conversely, some courts, including a few at the Circuit level, express skepticism regarding the legality of nonconsensual third-party releases, particularly when the entities in question are not directly involved in the bankruptcy case. These courts frequently cite concerns about infringing upon the legal rights of third parties who have not had their day in court. Professor Morrison suggests that the Supreme Court aims to clarify this issue by taking up the case and offers some predictions on how the case may be resolved
Some U.S. bankruptcy courts have used a multi-factor test to evaluate whether to grant nonconsensual third-party releases in bankruptcy proceedings. This test, sometimes referred to as the "Master Mortgage test," was derived from the 1996 case of In re Master Mortgage Investment Fund, Inc. and has been cited in numerous subsequent cases. The factors generally considered in this test include:
Identity of Interests: Whether there is an identity of interests between the debtor and the third party, often an indemnity relationship, such that a suit against the third party is, in essence, a suit against the debtor or will deplete the assets of the estate.
Necessity of Release: Whether the release of the third party is necessary for the debtor's reorganization. This can include showing that the third party contributes substantial assets to the bankruptcy estate and that the contribution is conditioned on the release.
Informed Voting: Whether the affected class or classes have overwhelmingly voted to accept the plan, including the third-party releases.
Plan Negotiations: Whether the plan has been accepted by a majority and amount of the creditors in the affected class, indicating a broad consensus of affected parties in favor of the plan and the included releases.
Impact of Release: Whether the release provision provides a critical element to the debtor's reorganization, enabling the debtor to deal effectively with its creditors.
No Blanket Releases: Whether the scope of the release is fair and not overreaching, releasing only those claims that are impacted by the reorganization and arise out of the debtor's business.
Notice: Whether affected parties have had a full and fair opportunity to participate in plan negotiations and whether they have been provided with adequate notice of the implications of the release and an opportunity to object.
Courts vary in how strictly they apply these factors and in the weight they give to each factor. Some courts may also modify or add additional criteria based on the specifics of the case. Therefore, while the seven-factor test offers a framework, its application is far from uniform.