Purdue Confronts Supreme Court Skeptical of Bankruptcy Power

The US Supreme Court’s longstanding skepticism towards bankruptcy courts’ authority poses a potentially debilitating obstacle for Purdue Pharma LP in its quest to grant liability releases to its Sackler family owners.

The key question presented in the Purdue case strikes at an issue the Supreme Court has considered multiple times: the extent of a bankruptcy court’s power. If the high court takes a narrow view of bankruptcy court authority, as it did in cases such as Stern v. Marshall and Czyzewski v. Jevic Holding Corp., it could spell major trouble for a settlement years in the making that stands to deliver billions of dollars to address the opioid crisis.

“Given the court’s existing jurisprudence, I would be personally shocked if they find there is statutory power for what the bankruptcy court approved in the Purdue case,” said University of Illinois College of Law bankruptcy professor Ralph Brubaker, who filed an amicus brief against Purdue in the case.

At stake in the case is whether non-bankrupt people and entities with ties to a corporate debtor can be released from liability without the consent of creditors. The Supreme Court’s ultimate decision could upend corporate bankruptcy practice, as the releases are a central bargaining chip in bankruptcy negotiations.

See also: Sacklers’ Fate at Supreme Court Poised to Reshape Bankruptcy Law

The Sacklers’ proposed releases, which would shield them against litigation accusing them of helping fuel the opioid crisis through their leadership of Purdue, were approved by a bankruptcy court in 2021 and upheld by the US Court of Appeals for the Second Circuit earlier this year.

But the Justice Department and some bankruptcy experts say the bankruptcy court didn’t have the authority to grant the releases in the first place. A federal district court judge rejected the releases before being overturned by the Second Circuit.

The Justice Department has also raised constitutional questions and said the supposed necessity of the releases doesn’t make them legal. Purdue and most of its creditors have pushed back. In the pharma company’s defense, it points to the same 1990 Supreme Court decision, United States v. Energy Resources Co., the Second Circuit cited when it upheld the Sacklers’ releases, which it says gives bankruptcy judges more leeway.

The Supreme Court will hear oral arguments on the Purdue case on Dec. 4.

“This is the most important bankruptcy case to be taken by the Supreme Court in decades,” Pamela Foohey, a bankruptcy law professor at Cardozo School of Law, said in an email.

Overly Pragmatic?

In Jevic, the Supreme Court held that bankruptcy courts can’t approve agreements that wander too far astray from the bankruptcy code. In the 2017 case, the high court determined that bankruptcy courts don’t have authority to sign off on agreements that change the creditor priority structure of the bankruptcy code without the consent of affected creditors.

“What the court is very careful about is letting judges get outside the parameters of the code,” said David Kuney, a former Sidley Austin restructuring partner who now has an appellate practice focusing on bankruptcy. “They’re very worried that judges will be pragmatic,” as opposed to sticking to the law, he added.

Bankruptcy court can became a high stakes game of “Let’s Make a Deal,” where judges are eager approve any deal debtors and creditors come up with in pursuit of a bankruptcy exit, he said.

“You can’t say that the law goes to the highest bidder. There’s got to be a long-term principal that carries forward,” Kuney, who is also an adjunct professor at Georgetown Law, added.

But the high court’s devotion to the bankruptcy code is also a product of the lack of restructuring expertise on the panel, Kuney said.

“The Supreme Court wants to be careful,” he said. “They don’t understand all the dynamics of bankruptcy law and they’re a little afraid of wrecking things, so they want to stay within the code.”

Another key decision, Stern, came in 2011 when the Supreme Court found that Congress impermissibly gave bankruptcy courts powers that belong only to courts that were established by the Constitution. The case involved the estates of former Playboy Playmate Anna Nicole Smith and her husband, oil magnate J. Howard Marshall, both of whom were deceased when the ruling was handed down.

Stern serves as a reminder that even when bankruptcy courts find authority in the bankruptcy code, they face further restraints because they weren’t created by the Constitution.

“That’s a type of reining-in powers,” Georgetown University bankruptcy law professor Adam Levitin said.

Stern is “consistent with this theme that there are hard limits on what the bankruptcy judges can do, not only in the statue but in the Constitution,” Brubaker said.

Appellate Review

A Supreme Court case last year hinted at a continued pattern of diminishing bankruptcy courts’ authority.

In MOAC Mall Holdings LLC v. Transform Holdco LLC, the Supreme Court unanimously held that district courts have jurisdiction to review certain sales approved by a bankruptcy court. In doing so, the court checked the finality of bankruptcy court approvals and left open the possibility of appellate review.

The case centered on who owned a $10-a-year lease for what used to be a three-story flagship Sears store in the Mall of America: the mall itself, or the company that purchased Sears when it went bankrupt. After a bankruptcy court ruled in its favor, Transform Holdco, which bought the iconic chain out of bankruptcy, argued Section 363(m) of the bankruptcy code deprived appellate courts from challenging the lease transfer.

The high court rejected that argument, finding that appellate courts have jurisdiction to review certain bankruptcy sales.

“It’s a way of trimming back bankruptcy court authority,” Levitin said.

But recent cases don’t necessarily offer clear guidance on what the court will do with Purdue, Foohey said.

“It’s hard to glean from prior recent cases what it may do with the issue in Purdue or how it may approach the Purdue case,” Foohey said in an email.

Implicit Powers

Purdue argues the bankruptcy code allows for the releases it seeks for the Sacklers. It points to a Supreme Court case that the Second Circuit relied on when it backed Purdue’s plan earlier this year.

The high court’s 1990 decision in United States v. Energy Resources Co. focused on part of a bankruptcy plan that required the Internal Revenue Service to apply tax payments to offset some of a debtor’s tax obligations—something not explicitly authorized in the bankruptcy code.

But the Supreme Court’s opinion quoted part of the bankruptcy code that gives courts the power to approve plans, including “any other appropriate provision not inconsistent with the applicable provisions of this title.” The Supreme Court said that amounts to “residual authority to approve reorganization plans.”

“These statutory directives are consistent with the traditional understanding that bankruptcy courts, as courts of equity, have broad authority to modify creditor-debtor relationships,” the court said at the time.

But Brubaker and other bankruptcy professors say Purdue is reading too much into that 1990 decision. Energy Resources upheld a bankruptcy court’s power to compel the IRS to treat tax liabilities in a way that was necessary for plan approval. That actually indicates that the Purdue liability releases are improper, according to the professors’ amicus brief.

Purdue’s reading of the Energy Resources case seeks to turn it “into a vast reservoir of extraordinary and unlimited implicit equitable powers, untethered to any explicit statutory authority,” the brief says.

The dissonance between the two interpretations of the 1990 case points to a broader disagreement.

“In general there’s a disconnect between how the Supreme Court views things, which is you have to stick to the statute, and bankruptcy courts, which is the statute is a starting point,” Levitin said.

The case is William K. Harrington v. Purdue Pharma LP, U.S., No. 23-124, 12/4/23.