Non-Consensual Third Party Releases and the Bankruptcy Court’s Constitutional Adjudicatory Authority in Light of Stern v. Marshall

Article

The Business Advisor

April 2017

On March 20, 2017, Chief Judge Leonard P. Stark of the U.S. District Court for the District of Delaware (“the District Court”) issued an opinion remanding for further proceedings an order of the Delaware Bankruptcy Court (“the Bankruptcy Court”) that confirmed a joint chapter 11 plan of reorganization containing a non-debtor third party release over the objection of affected creditors.1

In the underlying jointly administered bankruptcy cases, debtors Millennium Lab Holdings II, LLC, Millennium Health, LLC, and RxAnte, LLC (collectively, “the Debtors”), having reached a $256 million settlement prepetition with the U.S. Department of Justice and various other governmental entities to resolve, among other things, certain Medicare fraud and RICO claims asserted against the companies (“the Government Claims”), negotiated a prepackaged plan of reorganization (“the Plan”) with an ad hoc group of its prepetition lenders (“the Participating Lenders”) holding approximately 86 percent of the aggregate prepetition amount outstanding under a 2014, $1.75 billion credit agreement (“the Credit Facility”).2

The Plan provided a basis for the continuation of the Debtors’ businesses, with its centerpiece being a $325 million contribution from the Debtors’ equity-owners, non-debtors Millennium Lab Holdings, Inc. and TA Millennium, Inc. (“the Equity Owners”), and the restructuring of the Credit Facility.3 Specifically, under the Plan, the Equity Owners would terminate their ownership interests in the Debtors and contribute $325 million to the Debtors to be used, inter alia, to pay the settlement on the Government Claims, as well as to provide the Participating Lenders with $50 million for their agreement to support the Plan. The Plan also provided for: the conversion of the balance of the Credit Facility into $600 million of new term loans and the transfer of 100 percent of the beneficial ownership of Debtors to the lenders under the Credit Facility. In exchange for the $325 million contribution and the termination of their equity interests, the Plan provided that the Equity Owners and certain related parties, including the Debtors’ officers and directors, would receive full releases of any and all claims, including direct claims held by creditors, relating to, among other things, any prepetition actions or transactions in any way related to the Debtors, the Government Claims, and the Credit Agreement (“the Releases”).4 Certain of the Debtors’ prepetition lenders under the Credit Facility (“the Opt-Out Lenders”) with claims against the Equity Owners and certain other non-Debtor beneficiaries of the Releases voted against the Plan and objected to the Releases.5

On December 14, 2015, over the objections of the Opt-Out Lenders, bankruptcy judge Laurie Selber Silverstein confirmed the Plan, finding that the Bankruptcy Court had “related to” jurisdiction to approve the Releases and that “Stern v. Marshall6 does not change the conclusion that this Bankruptcy Court has jurisdiction.” The Opt-Out Lenders appealed.7

On appeal, while the Opt-Out Lenders raised several issues, their primary challenge was whether the Bankruptcy Court had the constitutional authority under Stern and its progeny to release and permanently enjoin their direct, state law and federal RICO claims against the Equity Owners and the other non-debtors without their consent.8

Under the doctrine of Stern v. Marshall, a 2011 decision decided by a 5-4 vote of the Supreme Court, an Article I bankruptcy judge lacks the constitutional authority to enter final judgments and orders except to the extent the claims before the bankruptcy court are core claims grounded on the bankruptcy clause of the Constitution or are common law claims that must necessarily be adjudicated in the claims allocation process that also arises out of the bankruptcy clause.9 The saga of the impact of the Stern decision was continued by the Supreme Court in 2015 with the Court’s ruling in Wellness International Network, Limited v. Sharif.10 There, the Supreme Court held that a bankruptcy judge may hear and finally determine Stern claims as long as the parties to the proceeding knowingly and voluntarily consent.11 The Opt-Out Lenders challenged the Bankruptcy Court’s approval of the Releases on the basis that such approval was a final order on their claims against the Equity Owners, which the Supreme Court’s decision in Stern and its progeny forbid as outside the constitutional adjudicatory authority of the Bankruptcy Court absent their consent.

In opposition, the Debtors, citing several bankruptcy cases within the district that have approved plans of reorganization which include third party releases over the objection of Stern challenges, argued that Stern did not alter the Bankruptcy Court’s jurisdiction and authority to approve the Releases.12 In the alternative, the Debtors argued that, even if the Bankruptcy Court lacked adjudicatory authority to enter a final order approving the non-consensual Releases, the District Court’s review and approval of the Bankruptcy Court’s order approving the Plan (“the Confirmation Order”) would simply cure the error and moot the Opt-Out Lenders’ appeal.13

The District Court disagreed with the Debtors’ assessment. Specifically, the District Court noted that while the Bankruptcy Court found that it had “related to” jurisdiction, which refers to the Bankruptcy Court’s subject matter jurisdiction, such a finding did not end the inquiry, as the Bankruptcy Court must also have “constitutional authority” as well.14 Reviewing the record on appeal, Chief Judge Stark found that it was unclear from the record the extent to which the Bankruptcy Court had the opportunity to evaluate the issue of its post-Stern adjudicatory authority to enter a final order discharging the Opt-Out Lenders’ non-bankruptcy state law claims against non-debtors without consent. Critical to the District Court was the fact that, in the confirmation order, Judge Silverstein expressly noted that, due to the necessities of the case, she did not have time to address the Stern argument but, nonetheless, went on to find that she did not need to address such issue because of her finding that she had “related to” jurisdiction.15

Turning to the merits of the Opt-Out Lenders’ arguments, the District Court examined the claims, finding them to be non-bankruptcy claims not stemming from the Debtors’ bankruptcy or necessarily capable of resolution in the claim allowance process; in other words, the very types of claims that the Supreme Court held in Stern are entitled to Article III adjudication. Having found the claims to be entitled to Article III adjudication, the District Court then noted that Stern forbids the Bankruptcy Court as an Article I court from entering a final judgement on such claims barring consent of the parties, which was not given by the Opt-Out Lenders.16 The District Court also rejected the Debtors’ argument that the Stern concern could be cured and mooted by the District Court’s de novo review of the Confirmation Order approving the Releases. The Court found that such a review would not resolve the constitutional concerns set forth in Stern because the Bankruptcy Court had not adjudicated the actual merits of claims that were subject to the Releases.17

Notwithstanding the merits of the Opt-Out Lenders’ arguments, however, having recognized that the Bankruptcy Court had not reached the Stern issue, Chief Judge Stark remanded the matter with instructions that the Bankruptcy Court consider, or clarify in its ruling, whether it has the constitutional authority to approve the Releases, post-Stern, over the objections of the Opt-Out Lenders. If the Bankruptcy Court finds that it lacks such authority, then it must submit proposed findings of fact and conclusions of law regarding the merits and final disposition of the Opt-Out Lenders’ claims. Alternatively, the District Court directed the Bankruptcy Court to simply remove the offending Releases from the Plan.

Although third party releases can be extremely useful tools in achieving funds necessary to allow a chapter 11 debtor to reorganize its business through a plan, the decision discussed above reminds us that they must not run afoul of the Bankruptcy Code and the protections it affords to creditors holding individual claims against the debtor’s equity owners and other related non-debtors. It remains to be seen if and how this case will impact the popularity of including third party releases in chapter 11 cases.18


1 Opt-Out Lenders v. Millennium Lab Holdings II, LLC (In re Millennium Lab Holdings II, LLC), 2017 U.S. Dist. LEXIS 39385 (D. Del. Mar. 20, 2017). The District Court’s initial Opinion was issued on March 17, 2017 but was amended to add a footnote that was inadvertently left out from the original Opinion.
2 Id. at *10 -11.
3 Id. at *12.
4 Id. at *12 – 13.
5 The Opt-Out Lenders filed a complaint in the Delaware District Court on December 9, 2015, approximately two days before the Plan was confirmed, against the Equity Owners and certain other non-Debtor beneficiaries of the Releases, asserting, among other things, that the Equity Owners had perpetrated a fraud on the lenders in connection with the Credit Facility.
6 Stern v. Marshall, 564 U.S. 462, 131 S. Ct. 2594, 180 L. Ed. 2d 475 (2011).
7 Contemporaneously with their appeal to the District Court, the Opt-Out Lenders sought certification of a direct appeal to the Third Circuit Court of Appeals, which was granted by the Bankruptcy Court. However, in an order dated February 22, 2016, the Third Circuit denied the petition for direct certification, and the appeal was then docketed with the District Court.
8 Millennium, 2017 U.S. Dist. LEXIS 39385 at. *26.
9 Stern, 564 U.S. at 475.
10 2015 U.S. LEXIS 3405, *1 (U.S. May 26, 2015).
11 Id. at *29-30.
12 Millennium, 2017 U.S. Dist. LEXIS 39385 at. *27-28.
13 Id.
14 Id. at 32.
15 Id. at 32-34.
16 Id. at 34-37.
17 Id.
18 By way of a brief procedural update, Bankruptcy Judge Silverstein held an initial hearing on the District Court’s remand on April 4, 2017, at which she ordered briefing on implications of Stern and its progeny on the Bankruptcy Court’s authority to release the Opt-Out Lenders’ claims against the Equity Owners and other third-parties without consent in the context of a confirmation hearing. It is anticipated that Judge Silverstein’s ruling on the remand will provide some clarity on the procedural steps a bankruptcy court must take in future cases in order to confirm a chapter 11 plan which includes nonconsensual third party releases.