Purdue Pharma Should Go Bankrupt. The Sacklers Shouldn’t

U ntil 2019, members of the Sackler family controlled pharmaceutical company Purdue Pharma. Should they be liable for civil suits following the company’s pending bankruptcy settlement for its deceptive marketing of OxyContin?

This is the question the Supreme Court will consider in December. The bankruptcy court of the Southern District of New York asserts it has the authority to implement nonconsensual third-party releases. These provide non-debtor third parties closely connected to the defendant (read: shareholders, board members, owners) immunity from related claims; i.e., those claims attributable to any wrongful acts alleged in the original claim, following Chapter 11 bankruptcy. It’s a controversial question, but supporters of such releases have the better economic argument. Third-party releases are crucial to the foundation of the limited-liability corporation: the fundamental economic unit of market economies.

To understand how the proceedings reached this point, some background is necessary.

On June 12, 2018, Massachusetts attorney general Maura Healey filed the first lawsuit against Purdue Pharma for deceiving “doctors and the public to get more people on addictive opioids.” In December 2018, Connecticut attorney general William Tong followed, suing Purdue Pharma for “peddling a series of falsehoods to push patients towards its opioids.” In 2019, following thousands of lawsuits filed against it, Purdue Pharma filed for Chapter 11 bankruptcy, putting a hold on all claims against the company. In 2020, Purdue Pharma — not Sackler family members themselves — pleaded guilty to a dual-count conspiracy to defraud the U.S. and violate several of its laws. Purdue also agreed to a civil settlement to resolve liability, as did the Sacklers themselves. The New York Times summarized that Purdue “pleaded guilty to marketing opioids to more than 100 doctors that it suspected of writing illegal prescriptions and lying about this to the DEA.”

Purdue’s plea had serious consequences. It entailed $8.3 billion in criminal fines, profit forfeiture, and civil penalties. It has led to the company’s reorganization as Knoa Pharma, a public-benefit corporation managed by the National Opioid Abatement Trust that will manufacture OxyContin and anti-addiction medication, with profits going to victim compensation, crisis abatement, and overdose medicine. The Sacklers also paid $225 million to the Department of Justice as part of the settlement, though they were not found guilty of wrongdoing themselves. The plea deal resolved civil claims against Purdue and the Sacklers, but not possible criminal claims against the latter.

Because Purdue Pharma pleaded guilty to the charges while in the process of bankruptcy, Judge Robert D. Drain of the Southern District of New York had “to approve the terms of the federal settlement,” as reported by the New York Times. In September 2021, Judge Drain approved Purdue Pharma’s Chapter 11 settlement, ruling that the Sacklers must turn over $4.5 billion to plaintiffs — states, counties, cities, and tribes — over nine years. The settlement granted a lifetime shield to those members of the Sackler family who were owners of Purdue against further civil suits on matters related to the OxyContin suits.

Plaintiffs, unsatisfied with the terms and offended by the liability shield granted to the Sacklers (whom they allege are guilty of directing Purdue’s malfeasance), appealed to the U.S. District Court for the Southern District of N.Y. In December 2021, Judge Colleen McMahon concurred with the plaintiffs and vacated the order on the grounds that Judge Drain lacked the authority to release the Sackler family from civil liability in further suits related to Purdue Pharma’s role in the opioid epidemic.

Purdue Pharma appealed the decision to the Second Circuit Court of Appeals. The appellate court reversed Judge McMahon’s ruling and increased the original $4.5 billion settlement to $6 billion.

By this point, all major plaintiffs were satisfied with the terms of the settlement — except for the U.S. Trustee, which affirms that Judge Drain and bankruptcy courts lack the constitutional authority to force third-party releases. U.S. solicitor general Elizabeth Prelogar, representing the U.S. Trustee, argued that establishing such a precedent would “create a back door that will allow the ‘wealthy and powerful’ to evade liability for wrongdoing without having to declare bankruptcy themselves,” as Amy Howe explains at SCOTUSblog. This month, the Supreme Court agreed to hear the case, temporarily blocking the settlement.

The DOJ maintains that bankruptcy courts have “no authority to force creditors to sign away their legal rights if they don’t like the settlement terms,” according to the Wall Street Journal. Todd Zywicki, an expert on bankruptcy law and professor at George Mason University’s Scalia Law School, agrees. “The bankruptcy court does not have the authority to compel third-party releases against non-debtor parties,” he told me. Zywicki acknowledges that his position, which he’s held for over 20 years and explains in the Heritage Foundation’s guide to the Constitution, is not the balanced approach taken by bankruptcy courts. The Journal reports that “Chapter 11 plans routinely include releases for private-equity firms, corporate executives and others with connections to a bankruptcy case but not bankrupt themselves.”

Limited-liability companies (LLC) and limited partnerships (LP), after all, are designed to encourage entrepreneurs to go into business by creating a legal distinction between the assets of the firm and shareholders’ personal wealth. In the former, all members cannot be held personally responsible for debts and liabilities incurred by the LLC, which exists as its own legal entity. In the latter, of which Purdue Pharma was one example, such limited liability applies to limited members.

Admittedly, the distinction between the assets of the business and those of its owners can be ambiguous. “Under certain circumstances, when a company is held liable, its owners can be held liable,” Zywicki said. “Especially when the owners clearly control the company and the line between the company and the shareholders is blurry.” Such is the case with Purdue Pharma.

The matter gets murkier still when one considers creditors’ allegation that “dividends previously paid to the family were part of a deliberate scheme to move money out of Purdue to thwart the collection of any future judgments.” The distinction may be arbitrary in this case, and upsetting to those hurt by the opioid epidemic, who feel they are owed even more compensation from the Sacklers themselves.

But the authority of bankruptcy courts to release third parties from related civil claims is economically prudent. The essential problem faced by bankruptcy courts is balancing the pro-investment incentives of limited liability against the concomitant moral hazard of conducting one’s business less responsibly than one would if his private wealth were at stake. The bankruptcy of limited-liability companies, limited partnerships, etc. and simultaneous protection of shareholders strikes the proper balance.

In the Purdue case, this balance translates to the plaintiffs’ receiving $6 billion, Sackler divestiture from the company, and proceeds from Knoa Pharma — Purdue Pharma, restructured — rebuilding communities plagued by opioid abuse. Meanwhile, the Sackler family is not forced into bankruptcy and acquires a shield from civil suits pertaining to Purdue Pharma’s OxyContin marketing.

Still, since the Sacklers have not been found guilty of wrongdoing in their private capacities, a path remains to lodge a criminal suit to garner damages for whatever wrongdoing is proven. Admittedly, proving criminal guilt is harder without the Sacklers themselves filing for bankruptcy. “When you go bankrupt, you open all of your correspondence to the claimants to make sure you’re not hiding assets,” Zywicki said.

Nonetheless, public outrage at the Sacklers’ private role in allegedly exacerbating the opioid epidemic should not be allowed to freeze the bankruptcy deal from going into effect and stall the distribution of $6 billion of funds to needy communities. Nor should such outrage be weaponized to take the “limited” out of “limited liability companies” and “limited partnerships” by depriving bankruptcy courts of their third-party release authority.