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UPDATE on Millennium Lab Holdings: Non-Consensual Third Party Releases and the Bankruptcy Court’s Constitutional Adjudicatory Authority in Light of Stern v. Marshall


The Business Advisor

Summer 2017

As noted in our last publication, 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 a 2015 order of the Delaware Bankruptcy Court (“the Bankruptcy Court”) confirming, over the objection of certain opt-out lenders, the joint chapter 11 plan of reorganization of the debtors in In re Millennium Lab Holdings II, LLC,1 which contained a non-debtor third party release provision granting a full release of any and all claims, including direct claims held by creditors to the equity owners and the officers and directors of the debtors (“the Releases”).2

By way of background, under the confirmed bankruptcy plan, which went into effect in December 2015 (the “Plan”), the Bankruptcy Court approved the Millennium Debtors’3 $256 million prepetition settlement with certain governmental agencies resolving, among other things, certain Medicare fraud and RICO claims asserted against the companies (“the Government Claims”). The Plan also approved the Debtors’ $325 million settlement with its equity owners, the proceeds of which would be used, inter alia, to pay the settlement on the Government Claims as well as to provide certain prepetition lenders who supported the Debtors’ plan with $50 million for their agreement to support the Plan. Certain of the Debtors’ prepetition lenders (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, alleging that the equity owners perpetrated an economic fraud on the lenders.4

In remanding the matter back to the Bankruptcy Court, the District Court instructed the Bankruptcy Court to clarify whether the Bankruptcy Court has the constitutional authority to release, over the objections of the Opt-out Lenders, the Opt-Out Lenders’ state law fraud claims against the equity owners, post-Stern v. Marshall.5 On remand, the Bankruptcy Court ordered the parties to brief the implications of Stern and its progeny on the Bankruptcy Court’s authority, in the context of a confirmation hearing, to release the Opt-Out Lenders’ claims against the Equity Owners and other third-parties without consent. Specifically, the Bankruptcy Court requested briefing as to how Stern can be reconciled with the Third Circuit Court of Appeal’s ruling in In re Continental Airlines,6 which predated Stern and is the controlling law in the circuit allowing bankruptcy courts to grant non-debtor third party releases under certain circumstances. On May 19, 2017, the proponents of the Debtors’ confirmed plan and the Opt-Out Lenders filed the requested briefs on the Bankruptcy Court’s authority to grant the Releases.

As expected, the proponents of the Plan fervently argued in their brief that the Bankruptcy Court has the constitutional authority to grant the Releases under Continental because the Releases were integral to the confirmed plan, since, without the Releases, the Debtors would have been forced to liquidate, destroying value for all stakeholders. Specifically, the plan proponents argued that the Stern decision “illustrates that the critical question in determining a bankruptcy court’s authority is not the abstract ‘nature’ of a claim (such as whether it arises from common law, federal law, or bankruptcy law), but whether resolving the matter is ‘integral to the restructuring of the debtor-creditor relationship.’”7

The plan proponents further argued that the Releases present no Stern issues because (1) Stern expressly made clear that bankruptcy courts can resolve so-called Stern claims as long as such resolution was integral to the debtor-creditor relationship; and (2) releasing a claim was not an adjudication of the merits of the claim, but an extinguishment of the claim regardless of its merits.8 Comparing the granting of a third party release extinguishing claims against non-debtors as equal to the discharge of state law claims against a debtor allowed under the Bankruptcy Code, the plan proponents contended that to treat every impairment or preemption of a claim as an adjudication of the merits of that claim that can only be done by an Article III court would be a breathtaking proposition that, taken to its logical conclusion, would end bankruptcy as we know it. In the alternative, the plan proponents argued, the Bankruptcy Court had the constitutional authority to enter the confirmation order approving the Releases because the Opt-Out Lenders consented to such authority by not objecting to the court’s authority in the first place. That action, argued the plan proponents, constituted a waiver by the Opt-Out Lenders of any objection to the Bankruptcy Court’s exercise of adjudicatory authority to grant the Releases.

Conversely, the Opt-Out Lenders argued that their claims are Stern claims because they are based on non-bankruptcy state substantive law against non-debtor parties that would not be resolved in the claims’ allowance process and, as such, the Bankruptcy Court lacked the constitutional authority to enter the confirmation order, which constituted a final judgment, disposing of such claims without consent.9 The Opt-Out Lenders argued further that, under Stern, “a bankruptcy court cannot deprive the holder of a Stern claim of its constitutional right to adjudication by an Article III court simply by effectuating that deprivation through plan confirmation.”10 Instead, argued the Opt-Out Lenders, the Bankruptcy Court must restore the confirmation order’s compliance with Article III by either striking the Release from the Plan as it applies to the Opt-Out Lenders’ claims or issuing proposed findings of facts and conclusions of law on the actual merits of the Opt-Out Lenders’ claims against the non-debtors after full discovery.11

Moreover, contrary to the plan proponents’ assertion, the Opt-Out Lenders state that they did not consent to the Bankruptcy Court’s adjudicatory authority to enter the Releases, as there was no express or implied waiver, and the reservation of rights provision included in their memorandum of law in support of their objection to the Plan expressly noted their objections to confirmation of the Plan and the approval of the Releases and injunctions contained therein, which should have put the Bankruptcy Court on notice that the Opt-Out Lenders were not consenting to the entry of a final judgment on their claims to the extent inconsistent with Article III of the Constitution.

As noted in our last article on this case, third party releases can be extremely useful tools in achieving the funds necessary to allow a chapter 11 debtor to reorganize its business through a bankruptcy plan and, in most cases, to obtain global peace among warring factions in the bankruptcy case. As such, the Bankruptcy Court’s ruling on this remand and any subsequent appellate rulings are matters of importance to chapter 11 practitioners.12 If it is determined that the Bankruptcy Court lacks the constitutional authority to grant non-consensual third party releases under a bankruptcy plan, such a ruling could hamper the ability of chapter 11 debtors to successfully reorganize.

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 *12 – 13.
3 The Debtors are Millennium Lab Holdings II, LLC, Millennium Health, LLC, and RxAnte, LLC.
4 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.
5 Stern v. Marshall, 564 U.S. 462, 131 S. Ct. 2594, 180 L. Ed. 2d 475 (2011).
6 203 F.3d 203 (3d Cir. 2000).
7 See In re Millennium Lab Holdings II, LLC, et al., Case No. 15-12284 (LSS), Supplemental Brief of the Debtors, TA Millennium, Inc., and James Slattery Regarding the Court’s Adjudicatory Authority and Related Issues on Remand From the District Court [Docket 437], [p. 1].
8 Id., pp. 10-12.
9 See In re Millennium Lab Holdings II, LLC, et al., Case No. 15-12284 (LSS), OPT-OUT Lenders’ Opening Brief on Remand Issues [Docket No. 439], pp. 12-13.
10 Id. at p. 20, 32-34 (noting that even if the inclusion of non-consensual third party releases in bankruptcy plans are authorized by the Third Circuit decision in Continental Airlines, that authorization must still comply with the requirements of Article III of the Constitution – an issue that Continental court simply did not address.)
11 Id. at pp. 24-28.
12 Briefing on the remand was completed in June 13, 2017; the Bankruptcy Court held oral argument on July 27, 2017, and the matter is currently under advisement with the Bankruptcy Court.