Sanofi v. Mallinckrodt: Delaware Decision Highlights Importance of Asset Sale Structures in Later Bankruptcy Proceedings

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In Sanofi-Aventis U.S. LLC v. Mallinckrodt PLC,1 the United States District Court for the District of Delaware ruled that a debtor that purchased intellectual property under a prepetition asset purchase agreement could continue to retain and use the property post-confirmation while discharging its obligations to pay any future royalties otherwise owed. The decision highlights the importance of structuring transactions up-front to minimize the consequences of future bankruptcies.

Background

Mallinckrodt PLC and its affiliated debtors (“Mallinckrodt”) filed bankruptcy petitions on October 12, 2020 in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). The dispute discussed here arose from a 2001 transaction in which Sanofi-Aventis U.S. LLC (“Sanofi”) sold to Mallinckrodt certain intellectual property, including trademarks relating to the prescription medicine Acthar Gel (the “Acthar Gel IP”), pursuant to an asset purchase agreement (the “APA”). As part of the sale consideration, Mallinckrodt agreed to pay some amount up-front and to pay an annual royalty equal to 1 percent of the net sales of Acthar Gel that exceed $10 million each year (the “Royalty”) for so long as Mallinckrodt (or any of its affiliates or successors) sold the product. Mallinckrodt granted Sanofi a purchase-money security interest in the Acthar Gel IP as collateral for the obligation to pay the up-front consideration but not the Royalty.

On October 13, 2021, in connection with the anticipated confirmation of Mallinckrodt’s chapter 11 plan, Sanofi filed a motion in the Bankruptcy Court seeking a determination that Mallinckrodt could not reject its obligations to pay the Royalty for sales arising post-confirmation. On November 4, 2021, the Bankruptcy Court denied Sanofi’s motion, finding that all claims for postpetition breaches (including the failure to pay the Royalty) constituted prepetition unsecured claims, which could be discharged upon confirmation. Sanofi appealed the issue to the United States District Court for the District of Delaware (the “District Court”).

District Court’s Opinion

The District Court began its analysis with the relevant statutes. Section 1141(d)(1)(A) of the Bankruptcy Code allows a debtor to discharge any debt that arose before the date of confirmation of a plan of reorganization.2 The Bankruptcy Code defines “debt” as “liability on a claim”3 and “claim” as a right to payment, even if such right is contingent.4 Thus, a contingent right to payment that existed pre-confirmation may be discharged in bankruptcy.5

In reviewing Third Circuit precedent, the District Court looked to In re Grossman, in which the Third Circuit, sitting en banc, held that with respect to torts in the bankruptcy context, a “claim” arises when an individual has a prepetition exposure to a product or other conduct giving rise to an injury underlying the claim even when the underlying injury has not manifested.6 The District Court explained that the Grossman rule “prefers an ‘expansive treatment’ of what claims may be discharged.”7

The District Court rejected Sanofi’s arguments that its claims for post-confirmation Royalties should not be considered contingent at the time of confirmation and that contingent claims should include only those dependent on extrinsic events over which the debtor had no control. The District Court found that Sanofi’s claims for future royalty payments were plainly contingent, as they depended on sales of Acthar Gel reaching certain thresholds, which in turn depended on several external factors. Further, the APA clearly contemplated the possibility of future Royalty payments when it was signed prepetition.8 Thus, Sanofi’s claim for the Royalty was a contingent claim, which may be discharged under section 1141(d)(1)(A) of the Bankruptcy Code.

The District Court next considered whether Sanofi’s claims for the Royalty arose in total at the time the APA was signed, rather than in each year the sales threshold triggering the Royalty payment was reached. The District Court considered conflicting case law regarding when a claim arises and determined that the answer depends on context. In this case, because Sanofi’s contingent claim for the Royalty was created by the APA — which was the “moment the parties fixed their rights against each other” — the claim itself necessarily arose at the time the APA was executed. The fact that the Royalty amount was meant to track the future success of the product did not transform it from an ordinary contingent claim into one that survives discharge and receives special payment priority over other unsecured claims.

Finally, the District Court rejected Sanofi’s argument that it would be unfair to permit Mallinckrodt to sell Acthar Gel without paying the Royalty, finding instead that to allow the Royalty to survive confirmation would give Sanofi special treatment over other general unsecured creditors for which it did not bargain. The District Court explained that Sanofi could have protected itself by taking a security interest in the assets sold to secure the Royalty (like it did for the up-front consideration), structuring the transaction as a license, or forming a joint venture with Mallinckrodt. Instead, Sanofi sold full title to the Acthar Gel IP, in exchange for a right to future contingent payments, and thereby assumed the risk of Mallinckrodt’s creditworthiness for the life of the Royalty. Thus, as the District Court noted, “Sanofi’s fairness arguments fall flat against the Bankruptcy Code’s base theme of a ‘fresh start.’”9

For the foregoing reasons, the District Court affirmed the ruling of the Bankruptcy Court that the Royalty could be discharged as a prepetition contingent claim.

Key Takeaways

The Delaware District Court, following Third Circuit precedent, favors an expansive definition of a “claim” that may be discharged in bankruptcy to include contingent claims that arise from obligations incurred prepetition, consistent with the broad definition of “claim” in section 101(5) of the Bankruptcy Code. Creditors with contingent payment obligations payable in the future that arise from prepetition substantive obligations should not expect special treatment that would give them payment priority over other general unsecured creditors and deprive the debtor of a fresh start where they have not bargained for credit support or other protections.

This decision highlights the importance of planning for contingencies — no matter how seemingly remote — when structuring a transaction involving long-term payment obligations. Rather than negotiating an unsecured payment stream as consideration, sellers of assets should consider seeking full payment of the consideration up-front or, if not possible, obtaining credit support or other protections that would give them payment security in a future bankruptcy of the purchaser counterparty, such as obtaining a security interest, a guarantee of payment, or otherwise retaining a property interest in the conveyed assets. Alternatively, an owner of intellectual property may prefer a licensing transaction with its “purchaser,” allowing the owner to retain ownership of the underlying intellectual property and leaving the potential future debtor-licensee to decide whether to pay attendant cure amounts to assume or reject the contract in bankruptcy, with attendant termination rights in the event of rejection.

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