Nondebtor Releases and the Future of Mass Torts

Certain members of the bankruptcy academy and bar seem to have their knickers in a twist over the Supreme Court’s grant of certiorari to review the nonconsensual nondebtor releases in Purdue. Conventional wisdom is that SCOTUS is going to find that there's no statutory authority whatsoever for nonconsensual nondebtor releases outside of the asbestos context (expressio unius and Congress doesn't hide elephants in mouseholes....).
Let's be clear: nonconsensual nondebtor releases are not necessary to resolve mass tort cases.

We've seen plenty of large, complex mass tort cases resolved without nonconsensual nondebtor releases. PG&E, for example, had nondebtor releases, but required creditors to affirmatively opt-in to them. And there are plenty more where the nondebtor releases were not essential to the economic deal, meaning that the plans would have been confirmed (perhaps with some relatively limited changes) if nondebtor releases were not on the table. Endo and Mallinckrodt, for example, would likely have had the same outcome without nondebtor releases. Most mass tort cases will be able to function as normal irrespective of what happens to the Purdue Pharma appeal.
What Purdue Pharma is likely to upset is the abusive practice of "inside out" bankruptcies, where most of the assets being administered belong to a nondebtor, meaning that the tail is wagging the dog. Those are the only cases where nondebtor releases are essential to the economic deal. Those are cases like Purdue Pharma, where most of the assets being administered are the Sacklers'; LTL, where it's J&J's assets; Aereo, where it's 3M's assets; and Boy Scouts of America, where it's various local councils' and insurers' assets. While we've seen a rash of these inside out cases recently, they are historically the exception. When the tail doesn't wag the dog, nondebtor releases just aren't essential for getting deals done.
For regular cases, nondebtor releases are a deal lubricant, but not a necessary one, and when they are nonconsensual, they are one that is incompatible with basic norms of due process. Of course it's easier to get deals done when the deal can be forced on nonconsenting parties. But it doesn't make deals impossible if you can't. All that prohibiting nondebtor releases will do is remove the possibility of the likes of J&J and the Sacklers resolving their tort liability on the cheap without filing for bankruptcy. Instead, they will have to decide if they'd rather pay full freight to resolve their tort liability or file for bankruptcy themselves. If they file for bankruptcy themselves, they'll have the same ability as any other debtor to obtain a discharge. (Yes, I recognize that the discharge issues are different for natural persons like the Sacklers....)
Now, proponents of forced nondebtor releases argue that the releases get more money for tort victims than would otherwise be available. Of course, they present absolutely no evidence to this effect, and their claim is wrong as a matter of economic theory. So again, let's be clear: permitting nonconsensual nondebtor releases reduces tort victims' recoveries.
Requiring that releases be consensual force “Coasean” bargaining among the parties, whereas nonconsensual releases allow nondebtors like the Sacklers to purchase a release for a discount from the market clearing price. To illustrate, recall that the attraction to nondebtors of obtaining releases through the bankruptcy process is the possibility of a global deal that binds all creditors. Now imagine a situation in which there are four creditors with claims against a nondebtor. One creditor is demanding $1 to settle, the second demands $2, the third demands $3, and the fourth demands $4. Suppose that the bankruptcy court can approve a nonconsensual release that binds all four creditors, as long as three consent, and that all creditors must be paid the same price. In such a situation, the nondebtor could settle for the “lowest winning bid” of $3/creditor or $12 total.
If, on the other hand, the bankruptcy court could only bind consenting creditors to the deal, then the price of a global deal that covered all four creditors would be at $4/creditor, or $16 total, because under a consensual release regime, the nondebtor will have to pay the “highest winning bid,” that is the actual market clearing price, for global peace. This illustration shows that a consensual release regime will result in greater recoveries for creditors if the nondebtor wants to achieve global peace through the bankruptcy.
To be sure, in a consensual release regime, the “highest winning bid” might be more than the nondebtor is willing to pay. Suppose, for example, that the fourth creditor demanded $40 billion, rather than $4 to settle. In that case, the nondebtor could simply choose to do a consensual deal in the bankruptcy with the first three creditors for $3/creditor or $9 total and then worry about the fourth creditor outside of the bankruptcy plan. It is the same thing as in the Rule 23(b)(3) class action context, when settling defendants have to deal with the opt-outs. They can either pay the highest winning bid or take their chance with the opt-outs. But notice that a deal still got done in bankruptcy with everyone who was willing to take it, and the fourth creditor is incentivized to take a deal in bankruptcy because there might not be enough assets left afterward to pay it if it gets a large judgment.
The “lowest winning bid” rule of nonconsensual releases makes it easier to achieve global deals on nondebtor releases by lowering the bid-ask spread, but this also means that the creditors will not receive top dollar. In a “lowest winning bid” regime, nondebtors are able to take advantage of some creditors’ desperation and liquidity needs to get a bargain vis-à-vis all creditors. And in some cases (LTL, Boy Scouts), we've seen nondebtors attempt to flood the bankruptcy electorate with junk claims that will support the releases in exchange for getting a modest payment when there is no liability owed to the junk claimants by anyone. A “highest winning bid” rule of consensual releases ensures that consenting creditors get the actual market clearing price and are at least as well off as under a nonconsensual release deal, and potentially better off. And it protects against the sort of ethically questionable manipulation of the bankruptcy mass tort electorate that has arisen in recent years.
To be sure, the “lowest winning bid” rule of nonconsensual releases mirrors the general Chapter 11 practice of allowing majorities to bind minorities. In regard to a debtor firm, this makes sense because the creditors are competing for a limited fund. If a deal made by a majority did not bind the minority, the bankruptcy would devolve into a grab race for the limited pot of assets. The same is true for Rule 23(b)(1)(B) mandatory class actions. Nondebtor releases, however, do not involve a true limited fund, as only an artificially agreed-upon amount of the nondebtor's funds are made available—until their funds are exhausted, there is no limited fund.
But who needs theory when we have an actual example from Purdue Pharma? The line that Purdue fed the bankruptcy court was that it is "as good a deal as there is to be had,"...until it faced appeals from eight states and the District. Then it somehow got the Sacklers to increase their contribution by 28% and cough up another $1.2 billion to get those jurisdictions to settle. Why shouldn't we now think that the Sacklers would pay even more if that's what's necessary to get peace with all of the non-consenting creditors? (Note also how J&J went from proposing chipping in $2.2 billion in LTL 1.0 to proposing an $8.9 billion contribution LTL 2.0....)
The other claim that gets made is that nondebtor releases somehow get money to tort victims faster. This argument is silly. Anyone who has ever dealt with a mass tort bankruptcy knows that money doesn't get to anyone fast--just because a trust is funded upon the effective date of a plan doesn't mean that the trust will be making distributions any time soon. Trust distribution procedures are never fast. And the typical settlement has payments made by the nondebtor over a decade or more. That's hardly a method for getting money to victims fast. You know what gets money to a tort victim fast? A final judgment in the tort system. If the concern is getting money to victims fast, speed up trials and appeals.
There's really no reason to think that nondebtor releases benefit anyone other than nondebtors who want the benefits of bankruptcy without paying the bankruptcy price. Unfortunately, part of the bankruptcy academy and bar is so reflexively defensive of primacy of "the Deal" and so scared of holdouts that it fails to recognize that the deal is only worth defending when it is a fair resolution. The realities of the bankruptcy process (e.g., venue, repeat players, DIP financing, RSAs, "independent" directors, plan exclusivity, hurry-up timelines) should make us hesitate to assume that majority assent is indicative of fairness.