In re Mallinckrodt PLC.: Delaware Bankruptcy Court Approves Non-Consensual Third-Party Releases in Contrast to Purdue and Ascena

Background

Mallinckrodt and its debtor affiliates (the “Debtors”) operate a global specialty biopharmaceutical company that produces and sells a variety of pharmaceutical products, including opioids. Prior to the filing of its bankruptcy cases, the Debtors faced numerous lawsuits in connection with its production of opioids as well as the marketing and sale of a drug called Acthar H.P. Gel (“Acthar”). In an effort to resolve the litigation, the Debtors reached principal terms of settlements with respective stakeholders,⁴ and on October 12, 2020, filed chapter 11 bankruptcy cases to finalize and implement those settlements through the Plan.

The Plan’s Releases

Nearly one year into the case, the Debtors proposed a chapter 11 plan which included four types of releases: (1) releases made by the Debtors; (2) releases made by non-debtor third parties whereby certain holders of claims and interests were given an opportunity to opt-out of the third-party releases by way of ballots or an “opt out form” by affirmatively checking an opt-out box (the “Opt-Out Third-Party Releases”); (3) non-consensual releases by opioid claimants (the “Non-Consensual Opioid Release”); and (4) releases by the Debtors and related parties of the opioid claimants.

Objections to the Releases

The Plan, including the releases therein, was overwhelmingly supported by the creditor body, with the exception of one creditor, the United States Trustee (“U.S. Trustee”), and the Securities and Exchange Commission (the “SEC”). The Non-Consensual Opioid Releases and the Third-Party Releases were the subject of objections lodged by the U.S. Trustee and the State of Rhode Island (“Rhode Island”) (together, the “Opioid Release Objectors”) and (2) the Third-Party Releases by the U.S. Trustee and the SEC (together, the “Third-Party Release Objectors”), respectively.⁵

The Opioid Release Objectors argued that the Non-Consensual Opioid Releases were “vastly overbroad, releasing persons and entities that did not contribute anything of value to the reorganization.” The U.S. Trustee also argued that the Bankruptcy Court lacks jurisdiction to approve the releases, and that approving them would be a violation of the opioid claimants’ due process rights.

With respect to the Opt-Out Third-Party Releases, the Third-Party Release Objectors argued that the opt-out procedure did not result in consensual releases because it released claims held by shareholders deemed to reject the plan and by unsecured creditors who were unimpaired or who did not return a ballot with the opt-out box checked. And therefore, such releases were subject to the Third Circuit’s requirements for non-consensual third-party releases set forth in In re Continental,⁶ which it cannot possibly satisfy.

The Bankruptcy Court’s Decision

Jurisdiction: Judge Dorsey concluded that, pursuant to Third Circuit precedent in In re Millennium Lab Holdings II, LLC,⁷ he had the requisite jurisdictional authority to approve the Non-Consensual Opioid Releases because these releases were integral to the success of the Debtors’ plan. Specifically, he concluded that, without the releases, settlements including those releases which were essential to the plan would not be effectuated, and, without the settlements, the plan would fall apart.

Non-Consensual Opioid Releases: Judge Dorsey found that the Non-Consensual Opioid Releases were indeed appropriate because these releases satisfy the Third Circuit’s standard set forth in In re Continental which requires that non-consensual third-party releases be (i) necessary to the reorganization and (ii) fair.

As to necessity, the Bankruptcy Court determined that the Non-Consensual Opioid Releases were necessary to the Debtors’ reorganization because the Non-Consensual Opioid Releases were an integral part of the settlements embodying them, and therefore a necessary component of the Plan. Moreover, with respect to the non-debtors being released, the Bankruptcy Court found that the Non-Consensual Opioid Releases were necessary because the entities and individuals were involved to such a degree with the Debtors’ business that a suit against them would likely to be a drain on the Debtors in some respect.

As to fairness, the Bankruptcy Court concluded that the Non-Consensual Opioid Releases were a fair result for opioid claimants as the relevant settlements were negotiated at arm’s length with a large group of sophisticated parties representing diverse interests and substantial consideration was being given in exchange for the releases in the form of a well-funded trust to which opioid claimants can turn for potential compensation. The Bankruptcy Court also concluded that Non-Consensual Opioid Releases were fair as to the non-debtors being released because the Debtors provided additional compensation in exchange for the releases of these non-debtors, and because the record suggests it was unlikely that there were any material claims for liability against these non-debtors that were being waived.

Notably, the Bankruptcy Court considered a number of additional factors in its decision to approve the Non-Consensual Opioid Releases. First, the court noted the “extraordinary nature” of the case due to the fact that the Debtors were the subject of over 3,000 lawsuits related to its opioid products and the fact that the settlement of claims relating thereto, to which the releases were an integral part of, will remove the threat of the lawsuits to the Debtors’ business while ensuring that the opioid claimants receive recoveries far in excess of what they could have obtained in continued litigation. The Bankruptcy Court also noted that, because the case was occurring at the height of a national opioid pandemic and that the nature of the claims arise from the use of opioids medication, time was of the essence. The Bankruptcy Court found it significant that the Non-Consensual Opioid Releases were overwhelmingly supported by the creditor body and the fact that only one creditor, Rhode Island, objected to the releases did not justify application of “a blanket prohibition on non-consensual releases” when the releases at issue otherwise satisfied Third Circuit requirements. Judge Dorsey further observed that practically speaking, the alternative to the Plan and the releases would be “protracted and expensive litigation, which would not help the victims of the opioid crisis but would instead generate significant litigation costs that would drastically reduce the funds available to opioid creditors.”⁸

Opt-Out Third Party Releases: The Bankruptcy Court overruled objections lodged by the Third-Party Release Objectors and instead concluded that the Opt-Out Third-Party Releases were consensual. In making this determination, Judge Dorsey examined the extent of the notice of the Opt-Out Third Party Releases and found ample evidence in the record that the Debtors made every effort to ensure that the releasing parties were sent notices in a variety of ways that clearly explained in “no uncertain terms” that action was required to preserve claims. Judge Dorsey also found relevant that the fact that the plan contained the Opt-Out Third-Party Releases was well-known and all Non-Debtor Releasing Parties (as defined in the Plan) had “countless” opportunities to opt-out, and only one did. The Bankruptcy Court, however, did make clear that any creditor that claims that they did not receive notice of their right to opt out will have the opportunity to seek relief from the Court to exercise their rights.

Summary of Key Takeaways

As recent decisions suggest, the validity of and authority for third-party releases are receiving increased focus resulting, in part, from the lack of uniformity. The District Court for the Southern District of New York in the Second Circuit and the District Court in the Eastern District of Virginia in the Fourth Circuit both invalidated non-consensual third party releases by putting into question the constitutional and/or statutory authority that bankruptcy courts have to approve such releases. In Mallinckrodt, the Bankruptcy Court here approved the third-party releases based on Third Circuit precedent.

The issue of third-party releases is an important issue for all stakeholders given the potential impact on bankruptcy case resolution and creditor recoveries. The common practice and reliance on the use of third party releases to maximize value to the estate and enhance creditor recoveries and current lack of judicial consistency suggests this issue is not presently resolved. Albeit in other contexts,⁹ in the past Congress has amended the Bankruptcy Code in response to specific chapter 11 proceedings¹⁰ to establish parameters on a debtor’s rights with respect to certain public policy interests. And in fact, we have seen this same action begin to unfold as Congress has introduced legislation prohibiting the use of third-party releases absent express written consent by each individual releasing creditor. Time will tell whether these issues are resolved, whether via the federal courts or federal legislation.

¹ In re Mallinckrodt PLC., Case No. 20-12522-JTD (Bankr. D. Del. Feb. 3, 2022) (Docket No. 6347).

² In re Purdue Pharma, L.P., 2021 WL 5979108 (S.D.N.Y. Dec. 16, 2021). For more information on the Purdue ruling and third-party releases in general, see David Meyer et al., In re Purdue Pharma L.P.: S.D.N.Y. Holds Bankruptcy Court Lacks Statutory Authority to Approve Sackler Family Releases, VELaw.com (Dec. 28, 2021), https://www.velaw.com/insights/in-re-purdue-pharma-l-p-s-d-n-y-holds-bankruptcy-court-lacks-statutory-authority-to-approve-sackler-family-releases/. In Purdue, the United States District Court for the Southern District of New York recently vacated Purdue’s plan of reorganization on the basis that the bankruptcy court did not have statutory authority to approve the releases contemplated therein. The plan proponents filed notices of appeal of the district court’s vacatur order and sought expedited appeal from the Second Circuit.  On January 27, 2022, the Second Circuit agreed to accept the appeal and scheduled oral arguments for April 2022.

³ Patterson v. Mahwah Bergen Retail Grp., Inc., No. 3:21cv167 (DJN), 2022 U.S. Dist. LEXIS 7431 (E.D. Va. Jan. 13, 2022). For more information on the Ascena ruling, third-party releases in general, and the “opt-in” versus “opt-out” debate, see David Meyer et al., District Court in Virginia Continues Questioning of Third-Party Releases – At Least in the Absence of Detailed Findings of Necessity, VELaw.com (Jan. 25, 2022), https://www.velaw.com/insights/district-court-in-virginia-continues-questioning-of-third-party-releases-at-least-in-the-absence-of-detailed-findings-of-necessity/. In Ascena, the United States District Court for the Eastern District of Virginia invalidated the debtor’s third-party releases contained in the debtor’s plan, holding that the bankruptcy court exceeded the constitutional limits of its authority by granting the third-party releases. The district court also rejected the “opt-out” mechanism used by the Debtors whereby purported releasing parties are deemed to consent to granting third-party releases if they do not affirmatively opt out of the releases. Ultimately, the district court remanded the case back to the bankruptcy court (and to a different bankruptcy judge) to consider confirmation of the plan without the third-party releases and with a modified exculpation provision. Appeals to the Fourth Circuit have not been filed and the debtors have filed a motion seeking an order to modify and reconfirm their plan consistent with the district court’s order.

⁴ Specifically, Mallinckrodt reached principal terms of a settlement of a comprehensive opioid settlement with Attorneys general of more than forty states and U.S. Territories which was later finalized following negotiations with a court-appointed committee in the national opioid multidistrict litigation and an ad hoc group of guaranteed unsecured notes. Settlement terms were also agreed upon with Centers for Medicare and Medicaid Services and the Department of Justice in connection with Acthar-related claims and investigations held by the federal government as well as each of the 50 states, Washington D.C., and Puerto Rico that would resolve claims asserted in a rebate related qui tam action. Mallinckrodt also entered into a restructuring agreement with various lender groups ultimately resulting in an agreement on a comprehensive restructuring. The original opioid settlement and the restructuring agreement were memorialized in a Restructuring Support Agreement (the “RSA”) which contemplated a comprehensive restructuring of the Debtors’ enterprise.

⁵ The Canadian Elevator Industry Pension Trust Fund (the “Pension Trust”) also objected to the Opt-Out Third-Party Releases; however, the Bankruptcy Court concluded that the Pension Trust did not have standing to object to the Opt-Out Third-Party Releases because it opted out of the releases and therefore is not bound by them.

⁶ 203 F.3d 203 (3d Cir. 2000).

⁷ 945 F.3d 126 (3d Cir. 2019).

⁸ In re Mallinckrodt PLC., Docket No. 6347, at 40.

⁹ See 11 U.S.C. §§1113 and 1114.

¹⁰ Section 1113 of the Bankruptcy Code was enacted in response to the United States Supreme Court’s holding in NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984) that section 365 of the Bankruptcy Code conferred on a debtor the broad power to reject collective bargaining agreements. Similarly, the enactment of section 1114 of the Bankruptcy Code was precipitated by a debtor’s attempt to reject retiree benefit contracts. See Chateaugay Corp. v. LTV Steel Co., 943 F.2d 1203 (2d Cir. 1991).