Supreme Court Ruling on Bankruptcy Releases: A Game Changer for Private Equity?

While I was researching the impact of the fall of the ‘Chevron Deference’ on private equity, a Wall Street Journal article (https://www.wsj.com/articles/supreme-court-kills-a-favorite-liability-shield-for-private-equity-ee4f38fb -- unfortunately behind the WSJ ‘Pro’ paywall) brought my attention to another “landmark decision” that I had initially ignored. This decision came in the case involving Purdue Pharma and its owners, the Sackler family. The court rejected Purdue’s bankruptcy plan, which included a $6 billion settlement that granted the Sacklers immunity from civil lawsuits related to their role in the opioid crisis. The court ruled that bankruptcy courts cannot extinguish claims against parties not in bankruptcy without the consent of those holding such claims.

The Importance of the Ruling:

This ruling dismantles a common strategy used in corporate restructurings known as nonconsensual third-party releases. For private equity investors, this liability shield has been a critical tool, especially for executives who serve on corporate boards and are frequently targeted by creditors for alleged breaches of fiduciary duties.

In the WSJ article, Jared Elias, a law professor at Harvard University, notes that businesses will now need to change their approach to the Chapter 11 process. Elliot Ganz, head of advocacy for the Loan Syndications & Trading Association, adds that restructurings will likely become more challenging and expensive as sponsor firms will need to negotiate and often pay for liability releases.

Anthony Casey, a law and economics professor at the University of Chicago, points out that creditors will gain more leverage, especially holdout creditors looking to extract more assets from a company’s backers.

While I have experience in private equity fund restructuring and even in purchasing funds out of receiverships, my experience in intense in-person creditor negotiations consists of reading about restructuring guys waiting for ‘saddlebags’ in Tom Wolf’s? ‘A Man in Full’ (which I guess is a Netflix series now? Does anyone recommend?) and reading about Chaim Fortgang throwing bagels at counterparties during creditor negotiations while yelling, “This is what you deserve!” (Read WSJ on bagel throwing https://www.wsj.com/articles/SB1014760154784300400)???

Impact on Private Equity:?

The initial reaction from the experts seems to indicate that creditors will be advantaged, with more leverage from more potential pockets to go after, while private equity firms are disadvantaged and will face increased costs and complexities in managing bankruptcies.? But is that actually the case?? Presumably, in a bankruptcy, the business is only worth so much.? As large bankruptcy processes are contentious and heavily negotiated, isn’t it likely that the creditors are already extracting as much as can be expected from the new capital?? If that is true, won't all parties simply now just have to agree to grant releases to all the third parties? (Or do the third parties have such limited leverage that the new equity will be happy to do a transaction without the third party releases and let the creditors and third parties fight it out?)

I could see this ruling giving pause to both private equity shops (and board directors') comfort with high leverage, especially with dividend recapitalizations where it later could be argued that board decisions were maximizing fund returns at the expense of company?health. (Of course, this argument would later be made by creditors, who presumably should be the throttle on ‘reasonable leverage’ at the time they grant the leverage, but I digress…)?

Call to Action:

Private equity professionals, how do you see this Supreme Court ruling impacting our industry? Are there specific steps firms should take to navigate this new legal environment? Should anyone rethink their tolerance for leverage, or willingness to serve on a board?? Let me know what you think are the biggest challenges and the biggest opportunities that will result from another landmark ruling this term.