The Rule of the Deal: Bankruptcy Bargains and Other Misnomers.

• Author: Lipson, Jonathan C.

Table of Contents 1. The Law and Theory of the Deal 1.1 The Law and Practice of Bankruptcy Bargains 1.1.1 Ex Ante Bargains--Restructuring Support Agreements 1.1.2 Ex Post Bargains 1.2 The Special Problem of Personal Injury/Wrongful Death Tort Claims 1.3. The Theory of the Deal 1.3.1 Contract Debates in Bankruptcy 1.3.2 The "New Bargaining Theory" and the Problem of Holdouts 2. The Sacklers' Social Debt and Bankruptcy Bargains 2.1 The Sacklers, Purdue Pharma, and the Opioid Crisis 2.2 Bankruptcy Bargains Implementing the Sackler Settlement Framework 2.2.1 Governance Changes--Shopping for Corporate Agents, Professionals and a Judge 2.2.2 The Preliminary Injunction and the Case Stipulation 2.2.3 The DOJ Settlement 2.3 Why Did Creditor Representatives Agree? 2.3.1 The Official Creditors' Committee 2.3.2 Ad Hoc Committees 3. Fallacies of the Rule of the Deal 3.1 The Contradictions of the Rule of the Deal 3.1.1 Creditor Support for the Releases 3.1.2 Sackler Separation from Purdue Pharma 3.2 The Economic Failings of Purdue Pharma Conclusion The conduct of bankruptcy proceedings not only should be right but must seem right (1)

Freedom of contract means, among other things, never having to say you are sorry (2).

Is chapter 11 governed by the rule of law--or the rule of the deal?

By "rule of law" I adopt Margaret Jane Radin's straightforward definition: "first, there must be rules; second, those rules must be capable of being followed." (3) "Rule of the deal," by contrast, describes bankruptcy's strong appetite for bilateral bargains--deals--among small groups of strategically placed stakeholders that can distort or deviate from positive law. These bankruptcy bargains may be "ex ante," as in the "restructuring support agreement" (RSA) early in a case, or "ex post," as in settlement or asset-sale agreements midway through a case. They are log-rolled through the case to gain momentum toward a "grand bargain" that makes a plan of reorganization implementing those deals practically inevitable.

These bankruptcy bargains are not usually troublesome. They have long been the lifeblood of chapter 11 practice. They are also the subject of a large body of literature, which focuses mostly on their economic implications, and which typically asks whether they are coercive, or efficient, or--trickier-both? (4)

But they can be problematic in what I will call "social debt" bankruptcies. Social debt is financial liability for serious (e.g., criminal) misconduct, often involving violations of health and safety laws, made unsustainable due to persistent governance failures of transparency and accountability.

The chapter 11 reorganization of opioid maker Purdue Pharma, the subject of this article, is perhaps the most notorious example of a "social. debt" bankruptcy. In addition to other opioid makers (e.g., Endo (5)), other examples include organizational liability for large-scale sexual assault (e.g., over thirty Catholic organizations, (6) The Boy Scouts of America (7)), and alleged contributions to the crisis of gun violence (e.g., InfoWars (8)). "Social debt" is, in short, Ronald Coase's famous problem of social cost-externalities-- writ very large. (9)

The most important questions in social debt bankruptcies will involve transparency and accountability: how did the misconduct occur, and do we have some confidence that those responsible have, in fact, been held accountable in a legally and socially acceptable way? Often, these questions will be answered by collateral litigation, such as individual prosecutions or tort lawsuits. Those other processes involve adversity and confrontation over basic questions of liability where the rule of law is often at a premium. By their nature, they will produce information about the underlying allegations, and determine individual liability or innocence.

The rule of the deal, by contrast, focuses on maximizing creditor payouts. The rule of law and the rule of the deal are both necessary features of the legal system--almost everything settles--but social debt bankruptcies require more of the former than the latter.

Unfortunately, Purdue Pharma was the opposite. The case has received extraordinary attention, including congressional scrutiny, (10) front page coverage in The New York Times, (11) and even three episodes of Last Week Tonight with John Oliver (12) for "nondebtor releases" (NDRs) that would give Purdue Pharma's owners, the wealthy and secretive Sackler family, the "global peace" they have long sought for their alleged role in the opioid crisis (the "Sackler Releases"). (13)

A nondebtor release "operate[s] as a bankruptcy discharge arranged without a filing and without the safeguards of the Bankruptcy Code." (14) Thus, as others have observed, Purdue Pharma would give the Sacklers the benefits of bankruptcy without its burdens, including obligations of transparency (financial disclosure) and accountability (giving most assets to creditors). (15)

The Sackler Releases are as hot as bankruptcy gets. Critics call them an "outrage," (16) "lawless," (17) "shocking," (18) a "grift," (19) and flatly unconstitutional. (20) Among other things, they are not authorized by any provision of the Bankruptcy Code, may exceed bankruptcy court authority, and may violate due process. (21) Proponents counter that they are "necessary" and that creditors voted for them by large majorities when they approved Purdue Pharma's plan of reorganization. (22) In any case, they may say, governments--who were the most assertive of Purdue Pharma's 600,000 creditors--were actively involved, ameliorating concerns about the "social" nature of the debt at issue in the case.

As of this writing, it is not clear whether the Sacklers will "get away with it." (23) Although the Bankruptcy Court in Purdue Pharma approved the Sackler Releases, the District Court reversed on grounds that the Bankruptcy Code does not permit them. (24) The case is pending before the Second Circuit Court of Appeals, which may use it to clarify its position on NDRs, having previously worried that they might be "abused," but neither forbidding nor permitting them. (25)

Although Purdue Pharma has generated great heat, there has been less light. Wanting is an explanation of the dynamics that produced the Sackler Releases, to guide courts in future appeals in Purdue Pharma and in other similar cases. (26)

This article aims to fill the gap. It draws on primary case documents to show how bankruptcy bargains in Purdue Pharma made the Sackler Releases practically inevitable from the outset: (i) the selection of corporate agents, professionals, and a judge likely to implement a settlement framework that the Sacklers had agreed to with a small group of Purdue Pharma's 600,000 creditors before bankruptcy; (ii) a preliminary injunction and stipulation in which creditor representatives ceded important leverage against the Sacklers; and (iii) a settlement in 2020 with the Department of Justice (DOJ) that, as a practical matter, foreclosed all options other than the Sackler Releases.

Existing literature has no account for bankruptcy bargains in social debt cases. Nor could it, I argue here, because the logic of bankruptcy theory, doctrine, and practice seek to solve a problem of remedy-priority in right of distribution--whereas social debt bankruptcies may also involve the predicate question of liability. In Purdue Pharma, for example, the key question for many was about the truth of allegations that the Sacklers had knowingly sought to "turbocharge" the market for opioids, even after their company had previously pled guilty to federal drug-marketing charges. (27)

Perversely, perhaps tragically, Purdue Pharma's bankruptcy bargains not only undercut transparency and accountability; they were also a bad deal. It is not clear, for example, that it was the Sackler Releases that added value, but instead the resistance by creditors to them, as would be the case in any ordinary bargaining. Here, court-ordered mediations did result in the Sacklers increasing the face amount of their proposed contribution, but the net present value did not increase much because the payment period was. extended, while the projected value of the company--which creditors would "own" through a trust structure--declined significantly, according to monthly operating reports in the case. (28)

Nor should this be surprising. Chapter 11 already gives debtors in possession significant advantages, in particular control of decisions about a plan of reorganization and whether (and how) to litigate estate causes of action. Early bargains in Purdue Pharmafurther tilted the playing field in favor of the deal the Sacklers wanted, so resistance to it was hampered. Creditors were divided about that deal, and the subsidiary deals that would lead to it. The Sacklers would understandably want to take advantage of chapter 11's deal culture and a fragmented creditor body. The rule of the deal could force them together. But this assumed that a deal on terms framed by the Sacklers was the only option.

It did not have to be this way. Chapter 11 has mechanisms that can address problems of transparency and accountability. In Purdue Pharma, for example, these could have included a bellwether trial against the Sacklers; more fulsome disclosure of the results of investigations by estate fiduciaries (or the appointment of an examiner to do so); or simply a line-item on the ballot permitting creditors to opt out of the Sackler Release--thus treating it as the contract term it purports to be. None of these things happened, fueling public concern about the case.

This article makes three contributions. Part 1 describes the theory, doctrine, and practice of ex ante and ex post bankruptcy bargains. It shows that the former can be coercive and the latter are subject to standards focused on asset values and distributions. The deeper problem is that these mechanisms solve problems of remedy where liability is assumed or not...