On Monday, September 30, 2024, Bloomberg Law reported that a significant conflict over bankruptcy “opt-out” provisions has arisen among judges following the United States Supreme Court’s decision to reject Purdue Pharma’s bankruptcy plan. The high court’s 5-4 ruling in June declared that liability protections for members of the Sackler family, who own Purdue, were invalid because they were granted without the explicit consent of opioid victims and other creditors. However, the Supreme Court did not clarify what constitutes such consent, leaving bankruptcy judges with divergent interpretations.

The ambiguity surrounding consent in bankruptcy proceedings has prompted varying legal opinions across different jurisdictions, complicating the decision-making process for attorneys regarding where to file bankruptcy cases. Tom Califano, a restructuring partner at Sidley Austin LLP, noted that this uncertainty complicates the venue selection for bankruptcy filings.

Central to the ongoing debate is the issue of “opt-out” releases, which allow creditors voting on a bankruptcy plan to be deemed as having accepted the releases unless they actively indicate otherwise. The U.S. Trustee, the Justice Department’s bankruptcy oversight entity, has argued that creditors should provide affirmative consent for releases to be considered valid.

While the question of opt-out releases had been a topic of discussion prior to the Purdue ruling, it has gained urgency as courts are compelled to address it. The specifics of each bankruptcy plan’s release provisions will be critical in determining the outcomes, with details such as creditor notification procedures playing a significant role. Legal standards for assessing consent will also be pivotal as judges navigate these complex issues.

A notable example of this conflict is evident in the U.S. Bankruptcy Court for the Northern District of Texas, where judges have issued conflicting opinions within a month. Judge Scott W. Everett ruled against the legality of opt-out releases in the bankruptcy plan of Ebix Inc., a software and e-commerce services provider, citing the Purdue decision. He acknowledged that his interpretation conflicted with prior rulings in his district.

In contrast, Judge Stacey Jernigan, also in the Northern District of Texas, upheld the legality of opt-out releases in the bankruptcy plan of Eiger Biopharmaceuticals just weeks later. While she had previously approved opt-out mechanisms, Jernigan revisited the issue after the U.S. Trustee raised concerns following the Purdue ruling. She overruled the government’s objection to Eiger’s releases but acknowledged that questions regarding the nature of consent remain.

The inconsistency is not limited to Texas; judges in Delaware and the Southern District of New York have also reached different conclusions on the legality of opt-out provisions. In Delaware, Judge Craig T. Goldblatt indicated that the judges in that court have historically held differing views on what constitutes valid consent.

The debate over how consent should be determined continues, with some, including the U.S. Trustee, advocating for a standard based on contract law, which typically requires explicit affirmative actions from the parties involved. In his opinion regarding Smallhold Inc.’s bankruptcy plan, Goldblatt concluded that some release provisions met the consent requirements established by Purdue, given that creditors received clear instructions and a straightforward mechanism for opting out.

Conversely, Judge Everett supported the application of contract law, arguing that the deemed release of claims against non-debtors lacks authorization under the bankruptcy code. He emphasized that silence from creditors should not be interpreted as consent under Texas contract law.

In contrast, Judge Jernigan favored a comparison to class actions, pointing out that more than 100 creditors effectively opted out of releases in Eiger’s case, demonstrating the functionality of the opt-out mechanism.

Despite Jernigan’s ruling in favor of Eiger’s opt-out releases, she cautioned that debtors should not take for granted that such provisions will always be approved, as the specifics of individual cases are critical. Andrew Troop, a bankruptcy partner at Pillsbury Winthrop Shaw Pittman LLP, suggested that it may take time for judges to establish consistent criteria for opt-in and opt-out mechanisms.

As the legal landscape evolves, the potential for different interpretations of consent due to variations in state contract laws raises concerns. Many experts argue that the issue should be addressed under federal bankruptcy law rather than being influenced by the jurisdiction of individual federal bankruptcy courts.

In smaller bankruptcy cases with fewer creditors, the necessity for third-party releases may be diminished. For instance, after Judge Everett struck down certain releases in Ebix’s case, the company swiftly removed them from its bankruptcy plan, which was subsequently approved.

The implications of the Purdue ruling extend beyond large-scale tort cases, highlighting that smaller companies may also face similar challenges in bankruptcy proceedings. Gregory Jones of Stradling Yocca Carlson & Rauth LLP noted that in cases where companies are financially strained, contributions from owners may be necessary to facilitate victim compensation, albeit contingent upon obtaining liability protections.

 

 

Source: Bloomberg Law