In a recent opinion, Honorable Colleen McMahon of U.S. District Court for the Southern District of New York, ruled that non-consensual releases of creditors’ direct claims against non-debtors in a Bankruptcy reorganization plan are not allowed under the provisions of the United States Bankruptcy Code. In Re: Purdue Pharma LP. This ruling reverses the Bankruptcy Court’s order approving Purdue Pharma’s Chapter 11 Plan of Reorganization which, among other things, provided for the release of the Sackler family members and other non-debtors arising out of and with respect to their participation in the promotion and sale of OxyContin.

In a lengthy opinion, Judge McMahon held that the non-consensual releases of third parties contained in Purdue’s Reorganization Plan are not supported by the language of the Bankruptcy Code. Such a ruling applies to not only “bad actors” associated with the debtor, but also to other third parties whose liability is often wiped out in a bankruptcy plan, the most common of which are guarantors of the debtor’s liability.

Although Judge McMahon’s ruling is significant, it does not resolve the issue because there remains a split among the circuits as to the enforceability of such releases. For example, the Seventh Circuit (Indiana, Illinois and Wisconsin) holds that, in unique circumstances, third-party releases are permitted by the Bankruptcy Code. However, Judge McMahon’s Opinion is persuasive authority for other jurisdictions struggling with this issue. It has also primed this issue to be addressed by the U.S. Supreme Court.