A toxic mix: opioid victims’ $1bn hit from repeat pharma bankruptcy

A little over a year ago, victims of the opioid manufacturer Mallinckrodt were in line for a $1.7bn payout through to 2028.

At the time, the company had emerged from Chapter 11 bankruptcy protection proudly hailing its status as the first opioid manufacturer to successfully use the court process to reorganise and compensate victims.

By August this year, it was back in bankruptcy court. On Wednesday, the opioid victims’ settlement will be slashed by just over $1bn, if a US federal judge signs off on a bankruptcy plan to hand ownership of Mallinckrodt to a group of distressed debt hedge funds and other asset managers as expected.

Those harmed by the generic painkillers now only stand to receive a final $250mn payment before the Irish-domiciled company permanently extinguishes its liability.

The Mallinckrodt case is just the latest to highlight the shortcomings of a system imperfectly designed for handling so-called mass tort cases where many victims are harmed by similar hazardous products.

“The bankruptcy system has left victims with a fraction of the compensation they would have been entitled to outside of bankruptcy,” said Joseph Steinfeld, a lawyer who represents thousands of individual victims of Mallinckrodt opioids.

“Worse, they have no real power to object when creditors, who have a higher priority, can cram down their recoveries to next to nothing.”

In a trio of recent cases, appeals courts have questioned if the particular tools of American bankruptcy ultimately trample on the rights of victims who dissent from the negotiated bargain.

Purdue Pharma, the Sackler-owned company behind the powerful drug OxyContin, tried to use a $6bn bankruptcy settlement to shield members of the family from future lawsuits linked to the US opioid crisis. In August, the Supreme Court put that settlement on hold.

Johnson & Johnson has had its attempts to use the system to ringfence claims from consumers who claim its talcum powder causes cancer shut down by the bankruptcy courts twice.

And 3M, which attempted to use the Chapter 11 process to contain the damage from allegedly defective military earplugs, ultimately agreed to a $6bn settlement with 250,000 veterans outside of bankruptcy court after having its scheme dismissed by a federal judge.

The Mallinckrodt case shows just how victims who agree on multiyear settlements with companies in bankruptcy schemes can end up short-changed.

Many bankruptcy lawyers argue the Chapter 11 process gives victims more certainty, resolves claims quickly and avoids a trial lottery where juries can give some claimants large awards while others get nothing.

But after Mallinckrodt emerged from Chapter 11 protection in June 2022, it almost immediately proved unable to service both settlement obligations and its other debts. Worse than expected sales and rapidly rising interest rates, which sent the cost of servicing floating-rate loans soaring, were to blame.

“Mallinckrodt is a particularly poignant example that the record of mass tort bankruptcies is not as strong as restructuring lawyers often claim”, said Melissa Jacoby, a law professor at the University of North Carolina. 

The compromise deal due to be approved on Wednesday will wipe out the value of Mallinckrodt’s public equity. Its senior lenders and bondholders will take control of the company at a $3bn enterprise value, roughly half the valuation set in its 2022 bankruptcy case.

The reduction in payments to the trust representing opioid victims was “particularly gruesome”, a lawyer for the trust told the court in September — but also said it was the best outcome the trust could negotiate in a compromise rapidly hashed out between creditors over the summer.

In June, lenders and bondholders told the drugmaker not to wire $200mn it owed to the opioid trust as the financial creditors had more senior claims that were secured against company collateral. By contrast, the trust payments were unsecured and junior.

One large senior lender told the Financial Times that the opioid trust ultimately wrung out a good deal given its unsecured status and how much the company’s value had evaporated between bankruptcies.

Senior lenders and bondholders are recovering the equivalent of between 81 cents and 95 cents on the dollar through the equity in the reorganised Mallinckrodt, according to court filings. Second-priority secured creditors get as little as 11 cents: a deeper haircut than the more junior-ranked opioid trust.

A representative of the opioid trust, not authorised to speak publicly, acknowledged the outcome could have been worse. Mallinckrodt’s management pushed the more senior lenders and bondholders to allow the final $250mn financial concession to the trust.

“The only reason we have $250mn is that the company did the right thing on some level,” the representative said.

But even though the opioid trust now will only receive a fraction of the original settlement after the company’s latest financial distress, some important features of the original bankruptcy remained ironclad.

Under the terms of the earlier restructuring, the company and its management secured permanent legal releases preventing them from being sued over any alleged wrongdoing. All of Mallinckrodt’s current and future opioid claimants were forced to take the deal offered through the court-supervised bankruptcy process.

The representative of the opioid trust said that one option could have been for the trust to pursue fraud charges against the company in bankruptcy court over the busted 2022 scheme. But that move was deemed too expensive and risky a gambit.

“Lesson learned. Don’t take an unsecured payment stream over eight years in a company that is highly levered. Take as much cash upfront as you can,” the representative said.