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It is common for senior creditors of a distressed company to object when a cheque is about to be mailed out to parties ranking lower in the priority of payouts.

Those junior claims are likely soon to be worthless and it is argued that the cash out the door really should stay within the company, reserved for top creditors who eventually become the owners in a restructuring.

But what happens when those junior creditors are not aggressive hedge funds but rather victims of the US opioid crisis? Last week the pharma company Mallinckrodt wrote in a regulatory filing that its lenders and bondholders had asked the board to consider alternatives to making a mid-June, $200mn payment owed to a trust that paid out claims to parties once allegedly harmed by opioids manufactured and marketed by Mallinckrodt. 

In total, the company is to make $1.725bn in payments that run through 2028. The trust and schedule were created as part of a global settlement enacted last year after Mallinckrodt had filed for bankruptcy in 2020 in order to sort out its financial troubles and legal liabilities.

But since its reorganisation, the business has struggled under a pile of $3.5bn of expensive debt. The separate trust payments are unsecured and ranked junior to Mallinckrodt’s loans and bonds in the creditor structure. Some holders of that debt do not want any “leakage” of cash prior to another company restructuring inside or outside bankruptcy court. 

In a May letter written to the company board seen by the FT and first reported on by Bloomberg, lawyers for opioid victims warned the company about reneging on its obligations. “Does Mallinckrodt — do you — really want to short-change its (and your) opioid human victims and deny them the relief promised and so desperately needed. If so, to what end? To save the business for your secured debt holders? If you embark down the path that has been publicly discussed, you will have blood on your hands.”

Companies facing so-called mass tort liabilities — usually arising from defective or dangerous product that harmed thousands of victims — have increasingly turned to the US bankruptcy court. In that arena, US law has proved to be an efficient, if controversial, method for resolving disputes, allowing victims to get their economic redress while letting underlying businesses get out from underneath endless litigation. 

The Mallinckrodt bankruptcy deal was consensually settled among thousands of parties — US states and municipalities, individual victims, as well the typical holders of leveraged loans and junk bonds. Mallinckrodt’s rapid unravelling can be attributed to both misfortune of underperforming business and misguided confidence that there could be enough money in the pot to minimise the pain on both financial creditors and victims of wrongdoing.

When Mallinckrodt was trying to clinch its restructuring in 2021, it wrote in court papers that its case was the “first ever reorganisation of a defendant in the nationwide opioid litigation that will not come to be owned by opioid claimant trusts”.

The deal cut its debt load by only $1.3bn — junior bondholders took new equity while remaining senior creditors got new or reinstated debt in the NewCo. Mallinckrodt agreed to then fund the opioid trust over eight years and also separately set up a schedule to pay the US Department of Justice and others $260mn over several years related to a kickback and rebate scandal over the drug Acthar Gel. 

In financial projections built in 2021 during the bankruptcy, the company and its advisers expected it would reach operating cash flow of around $830mn in both 2022 and 2023. In 2022, Mallinckrodt hit just $675mn with the company forecasting as little as $510mn in 2023.

Worse yet, interest expense because of spiking interest rates has further hurt cash flow. The consequence is that there is simply not enough money to satisfy the obligations to the opioid trust. 

In a March research note, analysts at CreditSights said that the opioid settlement as an unsecured obligation would “arguably be dischargeable in a bankruptcy”. But should senior creditors attempt such a gambit, it would not be so straightforward. “[Given] the highly politicised nature of the opioid epidemic and the unpredictability of bankruptcy, generally, Mallinckrodt may not be able to easily jettison this liability in a future bankruptcy.”

Chapter 22 cases — where a company comes out of Chapter 11 but then its recovery plan fails — typically elicit feelings of embarrassment and ignominy. Anger and anguish will mark this one if opioid victims suffer further.

sujeet.indap@ft.com

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