Bankruptcy ‘Opt-Out’ Conflict Emerges Among Judges After Purdue

After the US Supreme Court threw out Purdue Pharma’s bankruptcy plan, judges—including two in the same district—have reached opposing answers to the big question the high court left unresolved.

The justices in a 5-4 June decision held that liability shields for the Sackler family members who own Purdue were illegal because they were granted without the consent of opioid victims and other creditors. But in his majority opinion, Justice Neil M. Gorsuch declined to say what qualifies as “consent” when creditors are voting on a bankruptcy plan.

His omission has led bankruptcy judges to produce a varied landscape, which could make it more difficult for lawyers to discern which venues they should file bankruptcies in.

“It does complicate the venue question,” Tom Califano, a restructuring partner at Sidley Austin LLP, said.

The main front in litigating consent is whether “opt-out” releases, through which creditors voting on a plan are deemed to accept releases unless they check a box on their ballot explicitly stating otherwise, can be considered consensual. Creditors should have to affirmatively consent to a release for a court to grant it, the Justice Department’s bankruptcy watchdog, the US Trustee, has said.

Though the opt-out issue had been floating around bankruptcy courts before the Purdue ruling, the issue will heat up as more courts are forced to address it.

The specifics of a company’s release provision will matter, and decisions could come down to details like notice procedures for creditors. Aside from the minutia of opt-out provisions, courts will also have to decide which legal standard is the right one for the consent question.

“Whether courts accept an opt-out provision will be developed in the case law in the coming years,” John D. Penn, a bankruptcy partner at Perkins Coie LLP, said. “During that time, the views of the different circuits will continue to be one of the venue factors considered by debtors’ attorneys.”

Two Views in Texas

The recent tension between consent standards is perhaps no clearer than in the US Bankruptcy Court for the Northern District of Texas, where judges reached conflicting answers a month apart from each other.

“It just shows you how controversial it is,” Califano, who represented the debtor in each of those Texas cases, said.

The Purdue decision rendered opt-out liability shields impermissible for the committee representing creditors, the post-bankruptcy company, lenders, and others released by Ebix Inc.'s plan, Judge Scott W. Everett of the Northern District of Texas ruled last month. When he struck down those releases in the software and e-commerce services provider’s bankruptcy plan, Everett acknowledged that his interpretation conflicted with prior rulings within his own district.

“I respectfully part ways with my colleagues,” he said in an Aug. 2 oral ruling.

Just a month later and a few steps down the hall, one of those colleagues, Judge Stacey Jernigan, returned to the opposite interpretation. Opt-out releases in Eiger Biopharmaceuticals’ bankruptcy plan were legal even after Purdue, she held on Sept. 5.

She noted that she had approved the opt-out mechanism in the past but came back to the issue when the US Trustee raised it following Purdue.

Jernigan overruled the government’s objection to Eiger’s relases, but said “there are questions that remain regarding consensual releases and what constitutes consent.”

The Texas judges noted that they’re not the only bankruptcy court to have internal division on the legality of “opt-outs.” Judges in Delaware and the Southern District of New York have also split on the issue, Everett said.

In Delaware, Judge Craig T. Goldblatt in a Sept. 25 opinion said the judges of that court “have long expressed differing views on what constitutes consent.”

Contracts v. Class Actions

To some, including the US Trustee, consent should be determined under the standards of contracts law, which often requires an affirmative act by a party.

Goldblatt, in his opinion on Smallhold Inc.'s bankruptcy plan, held that some release provisions met the requirement for consent established by Purdue. Creditors were given “clear and conspicuous” instructions, the ballot had a simple mechanism for opting out of releases, and the act of voting on the plan constituted an affirmative act, Goldblatt held.

However, he said creditors that don’t vote on the plan can’t be considered consenting to the releases. He indicated that the propriety of opt-out provisions may be case-specific.

“The Court does conclude that after Purdue Pharma, in a case like the one now before the Court, a creditor cannot be deemed to consent to a third-party release without some affirmative expression of the creditor’s consent,” he wrote.

In the Ebix case, Everett agreed that contracts law should guide bankruptcy courts.

“Nothing in the bankruptcy code or rules contemplates or authorizes the deemed release of a non-debtor’s claims against another non-debtor, so the matter is more accurately construed as one of contract between those non-debtor parties,” Everett said.

If contracts law is applied, then opt-outs become harder to approve, Everett said. Opt-out releases rely on the silence of creditors and call it consent, but silence doesn’t equal consent under Texas contracts law, he said.

The US Trustee’s arguments for contracts law were less successful in Jernigan’s courtroom. She determined that a comparison to class actions is more appropriate.

In Eiger’s case, more than 100 creditors opted out of the plan’s releases, showing that the opt-out method worked, Jernigan said.

US Trustee attorney Elizabeth Ziegler Young said the Justice Department is pursuing a uniform standard across the country. Eiger had sophisticated creditors with experienced bankruptcy counsel who knew to look for an opt-out box. Other cases will include individual creditors who don’t have lawyers to assist them, Ziegler Young said.

Despite ruling in favor of Eiger’s opt-out releases, Jernigan said debtors “shouldn’t assume it’s always going to get approved” and that the facts of individual cases will matter.

Judges will focus on the mechanism for demonstrating consent after the Purdue decision, Andrew Troop, a bankruptcy partner at Pillsbury Winthrop Shaw Pittman LLP, said.

“I think it’s going to take some time for judges themselves to come to their own criteria for opt-ins and opt-outs,” he said.

But if contracts law is the standard, which it has been in multiple courts, then states will have different answers to the consent question because of variations in their contracts laws, Troop said. Instead, the question should be one of federal bankruptcy law, he said.

“I don’t think it should be driven by the venue in which the federal bankruptcy court sits,” he said.

Reaching Small Cases

In cases that have smaller pools of creditors and a clear idea of the claims against a company, third party releases aren’t as important.

In Ebix, for example, the company quickly removed the releases from the plan after Everett struck them down. The judge then approved the new version.

Third party releases can play a role in some smaller cases, Gregory Jones, of Stradling Yocca Carlson & Rauth LLP, said. He recently worked on a small business bankruptcy where plaintiffs alleged that the company’s products contained cancer-causing talc powder.

The case showed that Purdue’s reach extends beyond giant tort cases, such as the sex abuse claims against the Boy Scouts of America and Catholic dioceses.

“Sometimes the companies are in such bad shape that the only way to have a plan to pay these victims is to have contributions from the people who own the companies, but they’re not going to contribute that money unless they get something out of it,” Jones said.