Supreme Court’s Purdue ruling could create greater risk and exposure for directors and officers of bankrupt companies

Third-party releases have often helped to streamline and accelerate the resolution of what would otherwise be more complex and challenging Chapter 11 bankruptcy proceedings, offering significant protections for directors and officers. But under a recent Supreme Court ruling, releases that would extinguish claims against non-debtor third parties are no longer permissible without the claimants’ consent.

The ruling means some bankruptcy cases could take more time to resolve — and could be more costly to directors and officers.

Purdue’s proposed shareholder release

In 2019, Purdue Pharma filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. The company faced catastrophic liability arising from its marketing and sales practices for OxyContin, an opioid drug widely blamed for the opioid addiction and overdose crisis.

Some members of the Sackler family, who owned Purdue Pharma, did not file for bankruptcy protection. At the time the company filed for bankruptcy protection, claims against both Purdue and the Sacklers arising from the opioid addiction epidemic were estimated to exceed $40 trillion.

In 2021, the U.S. Bankruptcy Court for the Southern District of New York confirmed a proposed reorganization plan for Purdue. The plan included a so-called “shareholder release” that purported to permanently enjoin certain third-party claims against the Sacklers arising from the opioid epidemic. In exchange, the Sacklers agreed to contribute approximately $6 billion towards a claims trust that would pay past, present, and future opioid-related claims.

Several stakeholders, including various third-party claimants and the U.S. trustee overseeing the Purdue bankruptcy, appealed the court’s confirmation of the plan. They argued that the shareholder release impermissibly extinguished claims against the Sacklers, who stood to receive what was essentially a discharge in bankruptcy, without actually having filed for bankruptcy protection themselves.

Although similar third-party releases have been approved in other contexts, the Purdue shareholder release was notable for also enjoining claims against the Sacklers for willful and malicious conduct. Such protections are not even available to debtors under the Bankruptcy Code.

On appeal, the U.S. District Court for the Southern District of New York overturned the bankruptcy court’s confirmation of the plan. The 2nd U.S. Circuit Court of Appeals, however, reversed the Southern District’s ruling, finding that the shareholder release was permissible under the Bankruptcy Code. The objecting parties ultimately appealed to the U.S. Supreme Court.

The court’s decision

On June 27, the Supreme Court held that a bankruptcy court may not extend to nondebtors (in this case, the Sacklers) the benefits of a Chapter 11 discharge, which is “usually reserved for debtors.” The 5-4 decision in Harrington v. Purdue Pharma LP (opens a new window) highlighted three key points:

The shareholder release would have enjoined all claims against the Sacklers, including claims for fraud and willful misconduct. These categories of claims are typically not subject to releases, or even discharges in bankruptcy.

The Sacklers had not committed all of their assets to the bankruptcy estate in exchange for a discharge. The approximately $6 billion the Sacklers had pledged was far short of the Sacklers’ total wealth, yet the Sacklers would have received what was effectively a Chapter 11 discharge.

Congress has expressly allowed nonconsensual releases of third-party claims in asbestos-related bankruptcies and if Congress had intended to allow such releases in other contexts, it would have so stated through an amendment to the Bankruptcy Code. As the majority said in its opinion, “[s]omeday, Congress may choose to add to the bankruptcy code special rules for opioid-related bankruptcies as it has for asbestos-related cases. Or it may choose not to do so. Either way, if a policy decision like that is to be made, it is for Congress to make.”

More exposure for executives of bankrupt companies

Until Purdue, the use of third-party releases in the context of bankruptcy offered directors and officers significant protection against what could otherwise be catastrophic and never-ending exposure to directors and officers liability (D&O) insurance claims. Third-party releases in bankruptcy also had the added benefit of “bringing peace” to protracted, and commonly piecemeal, litigation against directors and officers of bankrupt corporations.

Now that the Supreme Court has decided that such nonconsensual third-party releases of parties that have not filed for bankruptcy protection are not permitted as part of a Chapter 11 plan of reorganization, directors and officers of bankrupt corporations may face additional exposure. Companies facing potential insolvency should be prepared for greater underwriting scrutiny during upcoming renewals. Specifically, underwriters are likely to ask questions around how a company bankruptcy might be structured and whether it might be appropriate for any individuals to seek bankruptcy protection as well.

On the other hand, nonconsensual third-party releases in bankruptcy have typically only been used in mass-tort bankruptcy cases, such as those involving asbestos or clergy abuse claims. The vast majority of Chapter 11 plans of reorganization do not involve nonconsensual third-party releases, which should limit the impact of Purdue.

The decision, however, comes at a time of heightened concerns about corporate bankruptcies: For the year ending March 31, 2024, business bankruptcy filings increased more than 40% from the previous year (opens a new window), according to data from the Administrative Office of the U.S. Courts. Directors and officers should thus consult with their brokers and legal counsel to understand the ramifications of the Purdue decision, which is likely to lead to a less predictable D&O coverage landscape for companies that are struggling financially.