Oral Argument in Purdue Pharma: Observations and Comments
On April 29, 2022, the Second Circuit Court of Appeals heard oral argument in In re Purdue Pharma, L.P. (case number 22-110-bk et al.). Oral argument lasted for almost two hours, far longer than the typical 30 minutes allocated for oral argument. My law students in the Bankruptcy Advocacy Practicum at Georgetown University Law Center listened to the live stream of the argument. Here are some of our initial observations based on what we heard. I welcome thoughts from others on how the argument went and the likely outcome.
Disclosure: My students and I prepared an amicus brief in support of the District Court decision by Judge McMahon, reported at In re Purdue Pharma, L.P., 635 B.R. 26 (S.D.N.Y. 2021). Our brief argued that the third-party releases were impermissible because they infringed on the power of the states to exercise their police and regulatory power. We did not file the brief because shortly before the filing deadline, the eight states and the District of Columbia, who had been the primary appellees, agreed not to file briefs when the Sacklers increased their settlement offer to approximately $6.0 billion. A copy of the unfiled brief may be found at https://www.bankruptcyadvocacy.net.
Overall reaction of the Panel. The Panel consisted of Judges Jon Newman, Eunice Lee and Richard Wesley. Overall, the tenor and tone of the argument appeared to be that Judges Lee and Wesley had some doubts about the validity of third-party releases. Judge Newman seemed more favorably inclined to Purdue and its reliance on Bankruptcy Code § 1123(a)(5) and (b)(6)(discussed below). Oral argument for both Purdue and the Department of Justice were well done and impressive.
Was Metromedia controlling? Purdue’s core argument in its briefing (and its opening line at oral argument) was that it had relied upon the Second Circuit’s “decades of precedents authorizing and providing guidance on non-consensual third-party releases” as the foundation for its Plan of Reorganization, citing primarily In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141 (2d Cir. 2005).[1] It argued the District Court “diverged from this unbroken chain of authority.” [2]
The Great Unsettled question. Yet, at oral argument, when Purdue said the same thing, none of the Panel appeared to express agreement that Metromedia necessarily provided support for the Purdue Plan. One might have thought this argument would resonate with the Panel if they felt the case could be resolved based on Metromedia. Judge McMahon on the District Court had been openly critical of the Second Circuit for not previously having ruled on this “great unsettled question” as she called it. The Second Circuit said little to show it disagreed with the need to clarify its position. This was perhaps an important signal that the Second Circuit wanted to consider the issue fully and not just rely on Metromedia. While it is typically impossible to predict an outcome based on oral argument, this reaction by the Panel is noteworthy.
Search for governing Code language. The Panel seemed more interested in understanding what the Code states, as opposed to trying to piece together a decision based on earlier precedents. The core discussion focused on the meaning of Code § 1123(a)(5) which states that a plan shall provide adequate means of implementation and § 1123(b)(6) which states that a plan may “include any other appropriate provision not inconsistent with the applicable provisions of this title.”
Not inconsistent with Title 11? Counsel for the Department of Justice (“DOJ”) argued that nonconsensual third-party releases are indeed inconsistent with other provisions of the Code---pointing out, for example, that the Sacklers individually were not entitled to a discharge under §§ 523(a)(2), (4) and (6) because the claims against them were grounded in fraud. The District Court had said much the same. See In re Purdue, 635 B.R. at 106.
Release of fraud claims. Judge Wiley wanted to know if fraud claims were being released. DOJ counsel correctly pointed out that they were in the definition section of the Plan under “causes of action.” This seemed to confirm the point that the release for the Sacklers was indeed receiving a release they would not have been entitled to had they filed as individual debtors.
Express prohibition? The Panel asked DOJ where was the express statement in the Code that third-party releases are not permitted. Counsel said the releases were contrary to the notion that the Code only governs debtors and that Congress need not identify everything which is not permitted, and that the Code generally describes what is permitted. Counsel for DOJ gave the example of a library sign reading, “All Members must return books in two weeks.” He pointed out this sign did not mean that non-members did not have to return books in two weeks. It was a simple but telling example.
Any other appropriate provision. Judge Newman offered what he called a “soft ball” to counsel suggesting that a plan could include “any other appropriate provision” and that this was open-ended and might justify the third-party releases—without more. But other panel members wanted to know what limits were built into this phrase and were somewhat skeptical that bankruptcy courts had such open-ended power to affect the rights of third parties based just on this provision.
Discharge. Purdue argued that third party releases were not the same as a discharge in bankruptcy. The Panel seemed unimpressed with this key argument. We agree. The release coupled with an injunction has res judicata effect and precludes relitigating. The releases and injunction extinguish a claim. It seems doubtful that the Second Circuit will accept the notion that a release is not a discharge. “In form, a [third-party release] is a release; in effect, it may operate as a bankruptcy discharge arranged without a filing and without the safeguards of the Code.” In re Metromedia Fiber Network, Inc., 416 F.3d 136, 142 (2d Cir. 2005). Judge McMahon repeatedly referred to the release as a “discharge.” See, e.g., In re Purdue at 108.
Effect on governmental entities and saving lives. Purdue argued that they had worked hard to achieve a result that will save lives based on the Sackler’s contribution. At oral argument, counsel returned to this point repeatedly. Yet, a counter point is equally persuasive. The argument overlooks how many more future lives may be jeopardized by overruling the District Court. In future mass tort cases, where the owners are seeking a similar release, the strategy may be to offer less in the negotiations because they will now be confident that third-party releases have been found to be valid. It may be that the risk of legal outcome on appeal unfavorable to the Sacklers led to a substantial increase in their settlement offer from an initial offer of $3.0 billion to $6.0 billion. Would that change have been likely if the Second Circuit had clearly ruled that third-party releases were valid?
Police powers. When the Purdue case was appealed, the major parties objecting to the Plan, other than the DOJ, were the eight states and the District of Columbia (known as “the Nine.”) Thus, the issue about the releases mostly involved the impact of third-party releases on a governmental entities’ police and regulatory powers. This key dynamic, overlooked in much of the briefing, was critical. Oral argument did not touch on this important distinction. The brief prepared at Georgetown Law School addresses this issue.
We argue that teversal of the district court decision could cause widespread harm to governmental entities. Judge Drain had ruled that the Code operated as a form of “wholesale preemption” that could override state police and regulatory powers. In re Purdue Pharma, 633 B.R. 53, 113 (Bankr. S.D.N.Y. 2021). This core ruling was inconsistent with the Supreme Court’s holding in Medtronic v. Lohr, 518 U.S. 470, 475 (1996) where the Supreme Court sustained the long-standing presumption against preemption of a state’s police powers.
If left standing, the Bankruptcy Court’s ruling on federal preemption of police powers would give bankruptcy courts unanticipated powers to disrupt governmental functions. If the Code preempts state police powers, then any bankruptcy court could approve a plan that enjoins and discharges obligations arising from a broad range of state and federal governmental exercise of critical police and regulatory powers, including environmental hazards, zoning violations, and fraud. See, e.g., United States v. Commonwealth Comp. Inc. (In re Commonwealth Comp.), 913 F.2d 518, 521-22 (1990) (listing examples of police powers); see also Pac. Gas & Elec. Co v. California, 350 F.3d 932, 937 (9th Cir. 2003) (Department of Justice, as amicus, expressed concern that a broad application of preemption could preclude enforcement of the Clean Air Act, the Clean Water Act, and even regulations issued by the Nuclear Regulatory Commission).
DOJ has no economic interest? Purdue characterized DOJ as a party with no economic interest in the outcome. This is incorrect. See above. In In re Federal-Mogul Global, Inc., 684 F.3d 355, 381 (3rd Cir, 2012) eighteen states had filed an amicus brief arguing that the “across-the-board” preemption theory “would destroy [their]ability to preserve their regulatory authority in the face of a bankruptcy filing.”
Liquidation. Purdue argued that if the Second Circuit sustained the District Court it could lead to Purdue’s liquidation and the loss of benefits for victims. Purdue argued that this was an undisputed fact because Judge Drain found that if the plan was not confirmed the result would be Purdue’s liquidation. This argument was seemingly refuted, however, by the events following the filing of the appeal. Once the appeals were filed, and the Sacklers were at risk of having the releases held to be invalid they substantially increased their offer from approximately $4.3billion to over $6.0 billion. Thus, events following the notice of appeal suggest that the Sackers agreed to contribute more as the risk of a negative ruling increased. The requirement that releases be consensual may well force third parties in the future to make more meaningful contributions for their release.
Constitutional issue. Some vital issues were not argued at length—including whether under Article III, a bankruptcy court can ever permit a third-party release. Purdue’s briefing has sought to minimize the constitutional issue. “It is undisputed that the district court—and this Court—have Article III power to approve the releases as part of the Plan. Accordingly, even if the bankruptcy court lacked the constitutional power to do so, there is no constitutional impediment to the district court’s order or this court’s approval of the Plan.” Purdue Br., p. 66, n.13.
Professor Brubaker/Markell/G. Kuney amicus brief. However, leading scholars and academicians feel that the Constitutional issue is key and filed amicus briefs setting forth their arguments—but which were not highlighted during oral argument. Professor Ralph Brubaker’s amicus brief argues that the “Courts’ approval of nonconsensual nondebtors releases contravenes the separation of powers limitation embedded in the Constitutions’ Bankruptcy Clause, which gives Congress the exclusive power to authorize the discharge of indebtedness and to prescribe the circumstances under which such a discharge is appropriate.” (See Dkt. 603, p. 2).
Further, he believes that a release—joined with an injunction—is a discharge and that the distribution and discharge scheme of bankruptcy is at the heart of the Constitutional power of Congress—and that only Congress—has the power to fashion bankruptcy law on discharge and distribution. He then joins this with an argument under Erie R.R. Co v. Tompkins, 304 U.S. 64 (1938). He argues that when the Bankruptcy Courts create “factors” and rules that decide when such releases are valid, they are effectively creating federal common law, and thus usurping the role of Congress—which has not authorized such releases. The federal bankruptcy courts have no power to fashion federal common law of discharge. The grant of jurisdiction to the bankruptcy courts under 28 USC § 1334 is no different than the grant of power to the federal courts to hear diversity cases or supplemental jurisdiction. Both are subject to the Erie doctrine concerning federal common law.
Professor Adam Levitin’s amicus brief. Professor Levitin argued that third party releases are unconstitutional, and Congress cannot authorize them. See Dkt. 594. Professor Levitin’s brief argued that the court should focus on the original understanding of the Banrkuptcy Clause which says that “Congress shall have power . . . to establish . . . uniform laws on the subject of Bankruptcies . . . .” “The concept [of third-party releases] would have been utterly incomprehensible to the Framers.” To the Framers, the subject of Bankruptcies was “limited to the adjustment of the relationship between an insolvent debtor and the debtor’s creditors.” Id. at 10.
“In short, bankruptcy relief as understood by the Framers would have been limited solely to the debtor and would have been premised upon submission to a searching and invasive examination and surrender of all of the debtor’s asset. The Framers would not have been able to conceive of a bankruptcy resulting in the forced releases of creditors’ claims against nondebtors. Those nondebtors could not get a release of liability through the bankruptcy process because those nondebtors had not themselves committed acts of bankruptcy, submitted to an examine, and made all of their assets available to creditors. This original understanding of the Bankruptcy Clause indicates that Congress lacks the constitutional power to authorize nonconsensual release of non-debtors’ direct liability through the bankruptcy process.” Id.
His conclusion is important: “Any reading of the Bankruptcy Clause that does not limit the scope of Congress’ power to providing relief to the debtor risks transforming the Bankruptcy Clause from a narrow and particular power of Congress into the equivalent of a second “necessary and proper” clause that would allow Congress the free ranging power to restructure all manner of economic and property relationships as it sees fit.” (Levitin Br. 10-11).
Due Process. The due process discussion was short. Purdue argued it had given extensive notice of the release. DOJ pointed out that the content of the notice was less than clear. The briefing noted that not even the Sacklers could understand all of the terms of the release. The Panel did not pursue this argument at any length.
Likely date for ruling. No one can predict when the Court will rule. But there are some signs that it may expedite its ruling. First, The Second Circuit immediately quickly agreed to hear the appeal after Purdue sought permission for an interlocutory appeal. Second, it agreed to expedite briefing and oral argument and it agreed to permit briefing beyond the normal page limits. Third, it permitted oral argument to run for almost two hours despite a normal period of thirty minutes. And fourth the Panel appeared to be extremely well prepared, and familiar with many of the arguments. It appears to us that the Second Circuit was highly focused on the importance of this case and may expedite its ruling.
Future cases and the consequences of a ruling. A ruling in favor of the District Court would not necessarily doom all third-party releases, but it would doom non-consensual third-party releases. It would require parties who seek third-party releases to obtain consent from all or most of the affected third parties. The Department of Justice would likewise have to consent. Such a ruling might up the cost to third parties for such a release, but that result may be best for all.
[1] Petition of the Debtors for Permission to Appeal Pursuant to 28 U.S.C. § 1292(b), Case No. 22-85, Dkt. 1 p.1-2.
[2] Id. at 2.