Supreme Court Ruling Impacts Consumer Creditors of Bankrupt Companies

The Supreme Court’s ruling in Harrington v. Purdue Pharma, L.P., 2024 WL 3187799 (U.S. June 27, 2024), disallows a scheme by members of the Sackler family to use a corporate bankruptcy of the family-held Purdue Pharma to evade full liability for fraud, UDAP, and various tort claims arising from their individual roles in fomenting America’s devastating opioid crisis. This article explains both why the Court disallowed the scheme and the holding’s implications for consumer claims generally involving corporations in bankruptcy. The article lists a dozen steps victimized consumers can take to preserve their rights when faced with a corporate bankruptcy filing, with links for more detail.

What the Sacklers Did to Avoid Liability 

The facts as set out by the lower courts were stunning. In preparation for bankruptcy, the Sacklers siphoned off over $11 billion from their family-controlled Perdue Pharma, whose earnings were based on the marketing of OxyContin. While under the Sacklers’ direct control, Purdue Pharma made deliberately false and misleading representations about the drug’s highly addictive nature that led to an estimated 247,000 American deaths, with an estimated $53 to $72 billion annual costs to society. These costs included expenditures for addiction treatment, lost work productivity, and criminal justice costs. 

Between 1996 and 2019, when Purdue filed for chapter 11 relief, Purdue generated approximately $34 billion in revenue, mostly from the marketing of OxyContin. The Sacklers became one of the twenty wealthiest families in America. 

As of 2019, the corporation and the Sacklers individually faced over 3,000 UDAP and fraud-related lawsuits brought by the United States, forty-nine states, local government entities, U.S. and Canadian Native American tribes, and Canadian municipalities. The liabilities against Purdue and the Sacklers were estimated at more than $40 trillion. By the time Perdue Pharma (not the Sacklers as individuals) filed a chapter 11 bankruptcy, it was a shell company with no substantial assets to pay creditors. The Sacklers had placed the funds they withdrew from the corporation in family holding companies, trusts, and offshore accounts. 

The Sacklers picked the officers, management, and attorneys to guide Purdue through its bankruptcy. In the corporate bankruptcy Purdue proposed a plan that included an order discharging the Sacklers as individuals from all past and future liabilities arising from Purdue’s marketing of OxyContin. The discharge released the Sacklers from liability from the thousands of civil lawsuits while allowing them to keep much of their personal wealth. This would not be possible if the Sacklers filed for bankruptcy as individuals. 

That the Sackler family members were nonddebtors in the bankruptcy case meant they did not have to disclose their assets or liquidate their assets to pay creditors. Moreover, because the claims against them were based on fraud, willful injury to others, and civil penalties, a liquidation in an individual bankruptcy would not have discharged a large part of the Sacklers’ liabilities. The approved Purdue bankruptcy plan gave the Sacklers all the benefits of being individual bankruptcy debtors without the obligations.

In Purdue’s chapter 11 case individuals and entities who sought to bring direct claims against the Sacklers individually could not demand that the Sacklers provide disclosures of their assets and could not file proofs of claims and share in the distribution from a bankruptcy estate made up of the Sacklers’ assets. Creditors with direct claims against the Sackers were not even entitled to notices and opportunities to participate in hearings leading up to Purdue’s chapter 11 plan confirmation. These claims against individual Sacklers were never valued in a liquidation analysis used to determine whether the plan met basic chapter 11 requirements. 

Over objections from the U.S. Trustee and several creditors, the bankruptcy court ultimately entered an order confirming a chapter 11 plan that included a Sackler family contribution of $5.5 billion and released the Sackler family members from civil liability for past and future direct claims against them arising from the sale of OxyContin. The legality of this plan confirmation decision was the issue before the Supreme Court.  

The Supreme Court’s Holding

The Supreme Court’s ruling in Purdue resolved a split in the U.S. circuits over whether bankruptcy courts had authority to grant a discharge to a “nondebtor” without the consent of those who held claims against the nondebtor. In Purdue, the Second Circuit held that the bankruptcy court had this authority, relying on Bankruptcy Code § 1123(b)(6), which states that a plan may “include any other appropriate provision not inconsistent with the applicable provisions of this title.” 

The Supreme Court rejected this statutory interpretation, finding the provision could not mean that bankruptcy courts have the “ ‘radically different’ power to discharge debts of a nondebtor without the consent of the nondebtor claimant.” Purdue Pharma, at *7.

The Purdue Pharma dissent focused heavily on the potential consequences of undoing the plan— highlighting the Sacklers’ agreement to provide $5.5 billion to the Purdue bankruptcy estate and that over 95% of voting creditors favored the plan. But the only voting creditors were those with claims against the shell Purdue Pharma and not those with claims against the nondebtor Sacklers individually. 

The focus on the votes cast in favor of the plan ignores the realities of chapter 11 practice. To be eligible to vote, a claimant must have filed a timely proof of claim.  In many chapter 11 cases only a minority of claimants file proofs of claims, and this is overwhelmingly true when the claimants are unsophisticated consumers. Even among claimants who have filed claims, the proportion who vote on plan confirmation is low.  Even though 618,914 claims were properly filed claims in the Purdue case, only about 120,000 (about 20%) voted on the plan confirmation.

From the perspective of consumer claimants, the greater problem in large corporate bankruptcy cases is that plans are negotiated behind closed doors. As in the Purdue case, major stakeholders had the basic contours of the plan outlined before the bankruptcy case was filed. The bankruptcy court was going to give the Sacklers a broad release of liability in return for their payment of a sum of money to Purdue’s bankruptcy creditors. The plan was presented to voters on essentially a “take it or leave it” basis. 

The Supreme Court in Purdue Pharma addressed the rights of parties with direct claims against the nondebtor Sackler family members. A “Sackler” bankruptcy estate against which claimants could file proofs of claims never existed. Claims against the nondebtor Sacklers were not covered by any distribution from the Purdue Pharma bankruptcy estate. There was no Sackler bankruptcy plan to vote on. These claimants lost all rights against the Sacklers without any meaningful due process protections. 

Even the Sacklers multi-billion dollar offers to the Purdue Pharma creditors were not as generous as they seem. The plan proposals always allowed the Sacklers to pay over time, for periods of from nine to eighteen years. Considering the time value of their contributions and sound investment of the $11 billion they took from Purdue, the Sacklers could have ended up after the bankruptcy process with an amount close the $11 billion they started with.

The Sacklers planned the Purdue Pharma bankruptcy so that they could exercise maximum coercion over all stakeholders to include nondebtor releases in the plan. Despite the active involvement of a multitude of government entities, the Sacklers’ strategy worked well for them.  Allowing the Sacklers to prevail with this scheme would have drawn a roadmap for individuals responsible for the worst corporate abuses to escape accountability through the corporation’s bankruptcy. The next steps in recovering from the Sacklers individually will be complex, costly, and time-consuming, an unfortunate price of the bankruptcy court’s legal error.  

Other Approaches to Resolving Nondebtor Obligations in a Corporate Bankruptcy

With the law on nondebtor releases now clarified, this section considers other options for nondebtors whose business activities are related to the corporation in bankruptcy for resolving disputes with stakeholders:

Consensual releases.  The Supreme Court did not address the question whether bankruptcy courts can approve nondebtor releases when creditors of the nondebtor consent to the release. The concept of consensual nondebtor releases raises significant due process concerns. It is not clear how a claimant could make an informed decision to agree to a release of claims against a party that is under no disclosure or liquidation obligations in the bankruptcy case. While bankruptcy courts have approved consensual nondebtor releases in the past, important due process concerns must be addressed if the practice continues. This is particularly true when consumer creditors are involved. 

Nondebtors can file their own bankruptcy cases. Individual debtors may not be able to discharge certain debts if they file as individuals. Congress intended that bankruptcy work this way so that it does not reward fraudulent or willfully harmful conduct. 

Litigation. Instead of using their discretion to stay litigation involving nondebtors, bankruptcy courts can allow litigation to proceed outside the bankruptcy proceeding. The litigation can facilitate settlements based on informed assessments of nondebtor liabilities—something that is difficult in bankruptcy. Outside of bankruptcy, disputes involving large groups of consumers can be addressed in multi-district or class action litigation. Even when both the corporate debtor and related nondebtors are all defendants in the litigation, bankruptcy courts can abstain and allow the federal or state courts to address issues of liability. The automatic stay does not apply to many civil government enforcement proceedings brought against the corporate debtor, and bankruptcy courts should allow these proceedings to continue against both the debtor and nondebtors. 

Supreme Court’s Ruling Does Not Resolve Other Corporate Bankruptcy Problems  

Purdue Pharma involves a scheme by individuals who directed a company’s unlawful acts to manipulate their status as nondebtors to avoid their individual liabilities. The Court did not address another bankruptcy practice in which a nondebtor entity is used instead to extinguish claims of consumer creditors.  This occurs when a company in bankruptcy sells its assets “free and clear” of claims to a nondebtor company.  The assets are no longer available for claimants’ recoveries against either the bankrupt corporation or the new buyer. 

A bankruptcy court can be asked to authorize a sale of a company’s assets outside of the plan confirmation process, even to an entity specifically created for the purpose of acquiring the debtor’s assets. Bankruptcy Code § 363(b), (f).  This occurred, for example, in the chapter 11 case in which “Old General Motors” in 2009 transferred its assets to “New General Motors” free and clear of certain consumer claims against Old General Motors. The bankruptcy court can also authorize the transfer of a debtor’s assets to a nondebtor under its broad authority to confirm chapter 11 plans. Bankruptcy Code § 1123(a)(5).  See NCLC’s Consumer Bankruptcy Law and Practice § 18.9.3.

Nevertheless, the Bankruptcy Code § 363 specifically prohibits free and clear sales when the sale will extinguish claims arising from a wide range of consumer credit transactions. Bankruptcy Code § 363(o).  See NCLC’s Consumer Bankruptcy Law and Practice § 18.9.4.  In addition, Bankruptcy Code §§ 1123 and 1129 set out allowed and prohibited chapter 11 plan provisions, including that the plan was proposed in good faith. The plan’s proponent must also show that the plan satisfies the “best interests of creditors” test, including a valuation of the consumer claims that would be extinguished by an asset sale under a plan. Dismissal of the chapter 11 case may be appropriate when the debtor fails to establish this valuation.

Finally, a sale of a bankruptcy debtor’s assets free and clear of consumer creditors’ claims raises significant due process concerns, particularly for sales conducted outside the plan confirmation process. The bankruptcy court should not approve a sale that risks extinguishing rights of consumer creditors without effective notice and an opportunity to be heard.

A Dozen Consumer Creditor Strategies When a Company Files for Chapter 11 Bankruptcy Relief

A chapter 11 bankruptcy is not a consumer-friendly environment for consumers victimized by a debtor company’s practices. The proceedings are complex and accessible mainly through highly specialized professionals. An unsophisticated consumer, particularly someone with a single individual claim of small dollar value, can easily be cut off from the proceedings that formulate a chapter 11 plan. Corporate debtors whose conduct has harmed a great number of consumers can use the power imbalance in chapter 11 to manipulate proceedings in their favor.  Discharges of liability for nondebtors (such as those the Sackler family sought) routinely appear in corporate debtors’ chapter 11 plans.  

A detailed analysis of consumer rights and tactics when a business files a chapter 11 bankruptcy is found in NCLC’s Consumer Bankruptcy Law and Practice Chapter 18.  Here is a list of a dozen steps that consumer creditors can take, either on their own or joined by others:

1. Seek dismissal of the bankruptcy case. There are instances when keeping a company in bankruptcy can be a good option for consumer creditors. The bankruptcy forum provides helpful oversight and control over the debtor and its assets. There can be advantages to resolving the claims of all creditors in a single forum. In some cases, there may even be assets to be liquidated for the benefit of a wide range of creditors. Consumers’ claims may be entitled to priority treatment in a distribution, or the amounts owed them may qualify as nondischargeable debts.   

On the other hand, there are many instances where a company’s bankruptcy filing obstructs consumers from pursuing claims in appropriate nonbankruptcy forums, and the consumers’ claims may ultimately be discharged. In these situations, dismissal of the bankruptcy case may be in the consumers’ best interest. Strategies for achieving dismissal of a chapter 11 case are covered in NCLC’s Consumer Bankruptcy Law and Practice § 18.7.14. Any party in interest, including a consumer creditor, can seek dismissal of a chapter 11 case for cause. 11 U.S.C. § 1112(b). “Cause” for dismissal most often involves problems with the debtor’s conduct after the filing of a chapter 11 case, such as the failure to timely confirm a plan or the inability to perform under a plan. However, a chapter 11 case can also be dismissed if the debtor did not file for bankruptcy relief in good faith. 

The good faith standard looks at whether the debtor filed for relief with the intent to achieve a legitimate bankruptcy purpose. Appropriate purposes are to reorganize as a going concern or to liquidate assets to pay creditors. Indicators of bad faith include: pre-bankruptcy planning to move assets out of the debtor’s control to avoid their liquidation; a solvent company filing for bankruptcy relief in order to obstruct government enforcement proceedings; and filing for relief primarily as leverage to coerce “consensual” discharges for nondebtors, particularly where the nondebtors seek to extinguish debts they could not discharge as individual debtors. 

2. File a proof of claim. Once a chapter 11 bankruptcy has commenced, a consumer seeking relief must timely file a proof of claim. Otherwise, the consumer has few rights in the case. See generally NCLC’s Consumer Bankruptcy Law and Practice §§ 18.4.1 and 18.9.5.  

Corporate debtors anticipate that consumer creditors will not file claims in a chapter 11 case, and they are seldom disappointed. Consumer representatives should demand enhanced outreach and plain language communications to inform consumers of the need to file a proof of claim and the means to do so. Consumers may be perplexed by the idea that they have a “claim” when they have never been in litigation with the debtor. They may be confused about how to value an unliquidated claim. The bankruptcy court should extend claim filing deadlines when consumer participation rates are low.  

3. Filing a class proof of claim.  The filing of a class proof of claims on behalf of a group of individuals harmed by the debtor in the same way is allowed in most, but not all circuits.  This is particularly appropriate for employees owed wages or for borrowers harmed by a bankrupt business’s standardized abusive practice. The best practice is to combine a class proof of claim with a class adversary proceeding (a lawsuit filed in a bankruptcy case) and a motion seeking class certification consistent with Fed. R. Civ. Proc. 23.  See generally NCLC’s Consumer Bankruptcy Law and Practice §§ 14.6 and 18.4.2. 

4. Claim all appropriate priorities in the consumer’s proof of claim.  Consumer creditors’ legal claims are most likely to be treated as general unsecured claims and receive minimal or no distribution in chapter 11. However, certain types of claims are entitled to a priority treatment. The consumer must claim any applicable priority in the consumer’s proof of claim.  Common priorities available for consumers include: the consumer priority for certain deposits; the employee priorities for wages and employment benefits; and a priority for certain post-petition expenses necessary for operation of the estate in bankruptcy. See NCLC’s Consumer Bankruptcy Law and Practice §§ 18.5.3, 18.5.5, and 18.7.15.2. 

5. Designation of a consumer creditors committee. In a chapter 11 case the U.S. Trustee can appoint members to various creditors’ committees to represent groups of creditors in the plan development process. Consumer representatives can be included in existing committees, or an attorney can request that the court designate a special committee of consumer creditors. The committee can call for fair determinations of the value of consumers’ claims and protect consumers’ interests under the plan or under an agreement to sell estate assets. The committee can even pursue derivative claims against corporate insiders. The bankruptcy court must ensure that the committee has adequate funding provided from the debtor company’s assets.  See generally NCLC’s Consumer Bankruptcy Law and Practice § 18.7.3.

6. Appointment of an examiner. At the request of a party in interest, the bankruptcy court can appoint an examiner to investigate allegations of fraud or other irregularities in the affairs of the chapter 11 debtor. 11 U.S.C. § 1104(c). See NCLC’s Consumer Bankruptcy Law and Practice § 18.7.4.7. For example, the examiner can investigate a corporation’s prebankruptcy transfers of assets to nondebtors. The examiner’s findings can be the basis for proceedings to recover those assets as improper transfers, to seek appointment of a trustee to manage the debtor’s affairs, or to dismiss the case. See NCLC’s Consumer Bankruptcy Law and Practice § 18.7.6.

7. Work with state attorneys general and state and federal regulatory agencies. State attorneys general and many regulatory agencies at the state and federal levels have broad authority to enforce consumer protection laws on behalf of consumers, including state UDAP statutes. Involvement of a state attorney general’s office brings leverage and significant legal resources. Government enforcement proceedings are generally not subject to the automatic stay, and governmental entities can file a class proof of claim and pursue litigation in bankruptcy court on behalf of a class of consumers.

Nevertheless, state attorneys general are creatures of a political environment. While headlines announcing a large sum in settlement of consumer claims are good public relations, consumers may find out later that the attorney general settlement proceeds went to fill a state’s budget shortfalls and not to individual consumers.  Consumer representatives should insist on transparency and specificity in any proposed distribution to be implemented by state or local government entities of bankruptcy estate funds.  See NCLC’s Consumer Bankruptcy Law and Practice §§ 18.3.2 and 18.4.2.

8. Ensure effective notices to all affected consumers. Demand that the business in chapter 11 identify all consumers who were harmed by its unlawful conduct. The broadest possible group of potential claimants should receive notice of the bankruptcy filing, the procedures for filing a proof of claim, and other key developments in the bankruptcy case.

Notices to consumer creditors should not focus solely on the plan confirmation hearing. By the time of a confirmation hearing, the plan is often a fait accompli.  Demand notice to consumers of any significant event in the bankruptcy case that may affect their legal rights, including a sale of assets, any agreement that might impair the rights of creditors of nondebtors, or proceedings to stay nonbankruptcy litigation. See NCLC’s Consumer Bankruptcy Law and Practice §§ 18.4.1, 18.9.3, and 18.9.6. 

9. Consumer’s silence is not consent to a plan releasing a nondebtor’s liability. The Supreme Court in Purdue Pharma barred bankruptcy courts from approving chapter 11 plans that grant nonconsensual releases for nondebtors. The ruling may lead companies in bankruptcy to portray nondebtor releases as consensual when they are not. The Court expressly declined to address the question whether bankruptcy courts have authority to order the release of a nondebtor when the release purports to be consensual. 

Existing bankruptcy law does not provide a structure for evaluating claims against a nondebtor. The requirements for disclosure and liquidation do not apply to nondebtors. It is not clear how the creditor of a nondebtor is to arrive at an informed decision about the value of its claim in the context of chapter 11 time frames and procedures. The potential for nondebtor coercion, as the Sacklers exercised, can further deter sound decision-making. 

If bankruptcy courts have authority to approve any form of discharge of a nondebtor, disputes are likely to arise over what showing must be made to establish a voluntary and knowing consent to a such a discharge.  An affected party’s silence should not be construed as consent. Not casting a vote on a plan is not a knowing approval of the release. At a minimum, courts should mandate written consent of all concerned parties before a plan can effectuate a purported consensual release of a nondebtor. Creditors of the nondebtor should demand effective disclosures from the nondebtor and the opportunity to establish the value of their own claims. 

10. Scrutinize asset sales to ensure that consumer claims are preserved. A debtor seeking bankruptcy court approval to convey assets to a buyer free and clear of legal claims is often an attempt to extinguish consumers’ claims. But claims arising from most consumer credit transactions cannot be extinguished in a sale under Bankruptcy Code § 363. Nor can a consumer’s recoupment rights on a consumer debt be waived. Nevertheless, sale agreements and plan terms routinely purport to wipe out these types of claims. The consumer representative must ensure that due process rights of all affected consumers are recognized. See NCLC’s Consumer Bankruptcy Law and Practice §§ 18.9.3, 18.9.4. 

11. Ensure proper valuation of consumer claims as part of the chapter 11 plan confirmation process.  When a chapter 11 plan proposes to discharge all or part of a consumer’s legal claims against the corporate debtor over the consumer’s objection, the bankruptcy court must make certain findings as a condition of approving the plan. The consumer must receive property of a value not less than the amount it would receive if the debtor’s assets were liquidated in a chapter 7 case. Bankruptcy Code § 1129(a)(7). The corporate debtor must provide a liquidation analysis that indicates a valuation of the consumer creditors’ claims. Consumer representatives can challenge this evaluation if it does not reflect the merits of consumers’ claims. When valuation is disputed, an option is for the bankruptcy court to grant stay relief or apply the abstention doctrine to allow the claims to be valued through litigation in a nonbankruptcy court. See NCLC’s Consumer Bankruptcy Law and Practice § 18.7.9.

12. Demand disclosure of nondebtor’s assets as precondition to its bankruptcy discharge. Before consenting to release of nondebtors, in order to make an informed decision about their consent, affected consumer creditors should demand disclosure of the nondebtors’ assets, similar to the disclosures that a debtor must provide in a chapter 11 case. 11 U.S.C. § 1125(b); Fed. R. Bankr. P. 3017. See NCLC’s Consumer Bankruptcy Law and Practice § 18.7.7.