Two Steps Forward or Two Steps Back
One of the big themes appearing in this year’s National Conference of Bankruptcy Judges was the effect of mass tort cases on the bankruptcy system. The panel Mass Torts in Bankruptcy: Two Steps Forward or Two Steps Back focused on third party releases. The speakers were Hon. Craig Goldblatt (Bankr. D. Del.), Karen Cordry from the National Association of Attorneys’ General, Prof. Douglas
Baird and Sander
Third party releases have been in the news a lot lately. In Purdue Pharma and Mahwah Bergen Retail Group, District Courts struck down overly broad provisions, while they were allowed in the Mallinckrodt PLC case.
The panelists discussed the history of third party releases. Karen Cordry made the observation that the first time an innovation in the law is allowed it’s based on unique circumstances, then it’s allowed based on prior precedent and then it’s settled law.
Releases for Guarantors Disfavored
Third party releases were originally rejected by the Ninth and Tenth Circuits.Resorts Int’l v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394 (9th Cir. 1995); In re Western Real Estate Fund, Inc., et al., 922 F.2d 592 (10th Cir. 1991). . These cases involved guarantor liability. and relied on section 524(e) to say that the discharge in bankruptcy doesn’t benefit anyone other than the debtor.
The Fifth Circuit continued with a hard line, rejecting not only third party releases but exculpation clauses. Bank of New York Trust Co., NA v. Official Unsecured Creditors’ Comm. (In re Pacific Lumber Co.), 584 F.3d 229 (5th Cir. 2009). However, the Fifth Circuit’s ruling was not based on guarantor claims like the earlier 9th and 10th circuit decisions.
Mass Tort Cases Provide a Different Justification
Sander Esserman provided what he described as the other side of the story. In the Johns-Manville case, Judge Burton Lifland was faced with a mass tort case that, like the Railroad equity receiverships threatened to go on forever. There was a profitable company faced with tort suits. At first its one, two or three at a time. The company is winning most of the cases. The plaintiff’s lawyers threaten to just keep filing more suits until they got a big victory.
For Judge Lifland, the question was wow do we get
out of this mess? How do you
give protection to people who want to contribute to a plan? How do you
protect the right of future claimants? His solution was to create what was later codified as 11 U.S.C. Sec. 524(g). It provided for both payment of future claims and third party releases. When the insurance companies wrote a check, they would be done. The insurance companies needed a release because they could not be assured that tendering policy limits would be enough. They could be faced with bad faith claims, direct claims and policies without limits.
What made the plan work as a practical matter was that the vast majority of claims voted in favor, it protected constitutional jury trial rights for those who wanted to exercise them and without the third party release, there would be no plan. This was later codified into law by Congress. However, at the time, Judge Lifland was crafting a remedy without clear statutory authority.
The mass tort claims provide a clear counterpoint to the guarantor cases. In the mass tort cases, the releases were necessary to provide a greater economic benefit to the creditor body as a whole as opposed to merely protecting someone who did not want to file bankruptcy.
Ultimately the Third and Fourth Circuits endorsed third party releases in the mass tort context.
The Baird Hypothetical
Prof. Baird testified before Congress on July 28, 2021. In his testimony he presented the following hypothetical:
Corporation is a defendant in
mass tort litigation
There are claims about failure
to warn the public about danger of its product.
of the family are named defendants.
The family members had received substantial dividends.
After negotiations, the parties reach a global
settlement. The former owners agree to make payment into a trust, but only if they receive third party
It is estimated
creditors will get 85% of their claims paid.
92% of the creditors vote in favor of the plan.
Can the Court bind the 8% who voted no?
If the hypothetical sounds familiar, its very similar to the settlement with the Sackler family in the Purdue Pharma bankruptcy.
Prof. Baird argued that it’s not a discharge, it’s a
He pointed to the example that a trustee can
settle fraudulent transfer claims under 11 U.S.C. Sec. 544 even those those claims could have been pursued by creditors outside of bankruptcy.
He argued that the trustee is representing groups of claims that the debtor has with some third party. The Trustee is pursuing that claim on their account and settling that claim on their account.
The settling party is going to say, “Why should I
have one truce if the war isn’t over?”
He said, “This isn’t
He then said, I have two buts
coming. We should be dramatically
limiting third party releases. The parties getting released should be paying the full value of their liability and the settlement should receive overwhelming consent.
The Discussion Becomes Lively
On of the panelists (Karen Cordry I think) bemoaned the fact that every case was becoming special. She compared it to Lake Woebegone where all the children are above average.
She said that to say you can
have it in bankruptcy law doesn’t mean you have it in our bankruptcy law.
She asked do we have Section 544(c)? (Section 544 as written ends with Section 544(b)).
One of her fellows pointed out that we read lots
of things into the code. Even if we
don’t have an actual Section 544(c), we have a virtual Section 544(c).
However, someone their water on that idea by saying that you won’t get you anywhere with
the Supreme Court. This power was explicitly rejected by the Supreme Court in Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416 (1972).
The Texas Two Step
From there, the panel ventured into a discussion of the Texas Two Step. This was discussed extensively in other presentations so I am going to truncate my discussion here. Under the Texas Two Step, a company splits itself into an operating company and a liability company. It assigns all of the liabilities to the bad company. To avoid being a fraudulent conveyance, the good company has to assign sufficient assets to the bad company to cover the liabilities. This is a type of third party release because it is intended to shield the operating company from lawsuits. the whole premise of the Texas Two Step relies on the good company promising to pay all or most of the debts of the bad company in return for a release.
Prof. Baird said he saw two
issues. On the one hand, there is a slam dunk fraudulent conveyance claim without writing the big check. However, the problem is that the good company won’t write the check unless they get the third party release. To do this, you have to be able to accurately value the liabilities. What if the tort claims are actually weak?
Ms. Cordry said that it affects negotiating positions. If the States know that there is no possibility of a third party release, they can take one position. However, if the debtor can just go into court and get a release, there is more of an incentive to make the deal.
Opt In and Opt Out Releases.
The panel then switched the discussion to opt in releases. Creditors will
only be bound if they check a box saying they will be bound by release and the settling parties will only fund if 90% say yes. If creditors have the ability to take or leave the settlement, it is not controversial.
However, what if the release requires a creditor to opt out? That depends on how conspicuous the release language. One of the panelists referred to disclosures that contain so many words that it actually discloses very little. Instead of
creditor opting in, they have to opt out.
What if most
people don’t read and respond? What if only half of creditors return a ballot but 90% of those opt in and 10% opt out. Under an opt in release, that would mean that only 45% of creditors would have opted in. However, if it were an opt out release, only the 10% of the 50% who returned ballots opting out (5% in total) would be exempt from the release.
Using a 363 Sale to Obtain a Third Party Release
The panel also discussed a concept I had not thought of before. What is ABC Company owns an insurance policy. When it files bankruptcy, it proposes to sell all its rights under the policy back to the insurance company free and clear of liens. The sale would feature standard buyer protections, including that there would be no successor liability and there would be an injunction against
pursuing claims against the buyer. Assuming that it meets the section 363 standard is anything else required?
How is that
different than tendering policy limits?
How are third
party releases different than sales free and clear of liens?
Under another scenario, ABC Corp. has
assets sufficient to cover greatest estimate of liability but ABC Corp. thinks the tort system is random with winners and losers. It doesn’t want to put ABC Corp.
into bankruptcy because it will harm enterprise value.
What about doing a 363 type sale before hand? Sell the good company and leave a pot of cash in the bad company. The obvious problem here is that the good company has to file bankruptcy in order to do a sale free and clear of liens. If the parties attempt to do a 363 type sale outside of bankruptcy, it won’t have the statutory protections and could be attacked by creditors.
Is this a Problem Bankruptcy Can Solve?
Rather than resolving these mass injury problems through the tort system or bankruptcy, government can set up a specific program to handle these claims. For coal miners, Congress created a program to compensate victims of Black Lung Disease. Workman’s compensation laws protect employers at the state level.
Perhaps the solution to asbestos and opioids and other societal problems is for Congress to set up a collective scheme to be funded from tax dollars outside of bankruptcy. The biggest obstacle would be getting Congress to act in an era of divided governance and suspicion of big government programs. Notwithstanding the obstacles, Ms. Cordry said that such a collective program is the only way to accomplish the goal constitutionally.
The idea that the split in circuits over whether to allow third party releases is really a split between circuits dealing with guarantor claims and those dealing with mass tort claims was new to me.
The potential use of Section 363 sales to accomplish third party releases was also something I had not heard before.
I was also struck with the idea that bankruptcy courts dealing with new and thorny problems are like the engineered dinosaurs in Jurassic Park, that nature will find a way. Judge Lifland created Section 524(g) before Congress enacted it into law. It may be that the Code will follow the necessities of solving big, messy problems. Either that or the Supreme Court will squash the effort like the giant foot in the opening credits of Monty Python’s Flying Circus.
I am also struck by the similarities between bankruptcy and class actions. Bankruptcy is essentially a class action between the debtor and its creditors. If bankruptcy can be expanded to be a class action between the debtor, its creditors and persons liable to the debtor, it may be possible to solve these problems through the vehicle of a class settlement rather than trying to incorporate third party releases into bankruptcy law.
I have a draft of an article on third party releases that is going through the editing process. One realization that hits me when I attend programs like this is just how much updating I will have to do from my original draft in February 2022.
The materials for this panel can be found here.