Spotts Fain PC; Richmond, Virginia
The issue of nonconsensual third-party releases in chapter 11 plans continues to generate litigation. Releases and corresponding injunctions frequently insulate nondebtors — such as directors, officers or parent entities — from claims asserted by other nondebtors. Litigation regarding third-party releases has also involved jurisdictional issues, including those addressed in Stern v. Marshall. In March 2017, the U.S. District Court for the District of Delaware addressed that intersection in an appeal from the case of Millennium Lab Holdings II LLC.
The issue on appeal was whether the bankruptcy court had “the authority post-Stern to enter a final order discharging [the] Appellant’s non-bankruptcy state law claims against non-debtors without [the] Appellant’s consent.” The district court remanded the appeal so that the bankruptcy court could consider whether it had constitutional authority under Stern to approve the releases. In Millennium, the confirmed plan included a third-party release and injunction that protected the debtors’ equityholders (the “nondebtor equityholders”), as well as executives, from various claims, including common law fraud and Racketeer Influenced and Corrupt Organizations Act (“RICO”) claims asserted by certain pre-petition lenders (the “appellants”).
Released Parties Contributed $325 Million to the Plan in Exchange for the Releases
The debtors provided “diagnostic testing services and derive[d] significant revenue from Medicare and Medicaid reimbursements.” Pre-petition, in 2012, the Department of Justice (DOJ) began investigating the debtors’ billing practices. Consequently, in February and May 2015, the debtors’ Medicare billing privileges were revoked.
In May 2015, the debtors disclosed a settlement agreement to pay $250 million to the DOJ. In November 2015, the debtors filed chapter 11. However, in 2014, the debtors refinanced secured debt and also issued a special dividend to the nondebtor equityholders in the approximate amount of $1.3 billion.
The nondebtor equityholders contributed $325 million to the debtors’ plan. In return, the nondebtor equityholders were to receive “full releases and discharges of any and all claims against them and related parties — including any claims brought directly by non-Debtor lenders such as [the] Appellants — and including claims relating to the $1.3 billion special dividend that had been paid to the [nondebtor equityholders] while the Debtors were in the midst of the DOJ Investigation.”
Shortly before confirmation, the appellants filed a civil complaint with the district court, demanding a jury trial and asserting RICO, conspiracy, fraud and other claims against the nondebtor equityholders and executives of the debtors. In bankruptcy court, the appellants objected to confirmation, arguing that the bankruptcy court lacked “arising-in” or “related-to” jurisdiction to approve the third-party releases. The appellants argued that the plan must be amended to permit parties to opt-out of the third-party release, but even with such an amendment, the plan did not meet the criteria necessary for a third-party release under Third Circuit law.
Nonetheless, the bankruptcy court overruled the appellants’ objections and confirmed the plan with the nonconsensual third-party release intact. The bankruptcy court ruled that it had related-to jurisdiction but did not address its authority to enter a final order releasing the claims between nondebtors.
District Court’s Remand Offers Two Options
The district court first considered whether the bankruptcy court had constitutional authority to enter the confirmation order, including the nonconsensual third-party releases. While the bankruptcy court was express that it had related-to jurisdiction, it did not explain its reasoning. The district court noted the appellants’ failure to address head-on the argument that the bankruptcy court lacked constitutional authority to confirm the plan and ratify the releases, stating that it was “not convinced that the Bankruptcy Court ever had the opportunity to hear and rule on the adjudicatory authority issue.”
As to the substance of the parties’ arguments, the district court found that the claims are non-core and between nondebtors, which would not “be resolved through the claims allowance process.” The district court also noted that absent consent, the appellants may deserve adjudication of their claims by an Article III district court judge.
The district court stated that the release of the appellants’ claims was equivalent to a ruling on the merits. The district court also rebuked the debtors’ argument that its de novo review of the confirmation order would cure jurisdictional issues under Stern and Executive Benefits Insurance Agency v. Arkison. The matter was remanded to the bankruptcy court to consider or clarify whether it had constitutional authority to approve the releases and, “if it does not have such authority, to submit proposed findings of fact and conclusions of law regarding the final disposition of these claims through the Confirmation Order, or, alternatively, to strike the nonconsensual release of Appellants’ claims from the Confirmation Order.”
Is There a Workable Solution on Remand?
The practical application by the bankruptcy court of the district court’s decision appears difficult. The district court’s ruling favors the appellants’ contention that the bankruptcy court lacked constitutional authority to authorize the release and that their claims are instead entitled to Article III adjudication. Nonetheless, the district court remanded that issue to the bankruptcy court, which may now decide that it has constitutional authority to approve the releases; in the alternative, the bankruptcy court — absent constitutional authority to approve the releases — may either submit proposed findings of fact and conclusions of law to the district court or strike the releases from the confirmed plan.
If the bankruptcy court finds that it does not have constitutional authority, then neither the proposed findings and conclusions to the district court nor the striking the releases would be a workable, reliable remedy. If bankruptcy courts that entertain plans with third-party releases had to style confirmation orders as proposed findings and conclusions, then one of the key features and strengths of bankruptcy would be eliminated: the ability to confirm a plan quickly when faced with exigent circumstances.
Consider the delay in a plan’s effective date while awaiting de novo review from a district court. The same problem would occur if supplemental proposed findings and conclusions were submitted on the releases and injunctions alone because naturally a party seeking a release that intends to contribute to the plan would condition its contribution on ratification from the district court, which would place great uncertainty over the finality of a reorganization.
The second choice — striking the releases from the confirmation order — eviscerates the bargained-for exchange on which the released parties relied. In that possibility, the released parties are left without the return consideration for their support of the restructuring. Similar to the first choice, that option casts uncertainty on future restructurings. More importantly, that result would chill the willingness of future third parties to support and contribute to reorganizations, as well as likely diminish the returns for stakeholders and creditors.
On Remand, Judge Silverstein Finds She Has Constitutional Authority
On Oct. 3, 2017, Judge Laurie Selber Silverstein issued a 69-page opinion holding that she had the constitutional adjudicatory authority to approve the releases at confirmation. Accordingly, any need to either strike the releases or submit proposed findings and conclusions to the district court was obviated. Further, Judge Silverstein held that the appellants had forfeited and waived any argument that she lacked constitutional authority to enter the confirmation order containing the release because the appellants did not raise that particular objection at the confirmation hearing or before entry of the confirmation order.
After noting that plan confirmation is a statutory, “core” proceeding, Judge Silverstein held that a bankruptcy judge has constitutional adjudicatory authority to enter a confirmation order that contains a nonconsensual third-party release. As to the constitutional issues raised by Stern, she held that neither a narrow nor a broad interpretation of Stern precluded confirmation of the plan including the releases.
 564 U.S. 462 (2011).
 Opt-Out Lenders v. Millennium Lab Holdings II, No. 16-110-LPS, 2017 U.S. Dist. LEXIS 39385 (D. Del. March 20, 2017) (hereinafter, “Millennium”).
 Id. at *32.
 Id. at *37.
 Id. at *11.
 Id. at *13-14.
 Id. at *13-*16.
 Id. at *34.
 Id. (internal citations omitted).
 134 S. Ct. 2165 (2014) (holding that where claim falls within statutory meaning of “core” but may not constitutionally be resolved by bankruptcy judge, bankruptcy judge must issue proposed findings of fact and conclusions of law to be reviewed de novo by district court).
 Millennium at *37.
 In re Millennium Lab Holdings II LLC, et al., Case No. 15-12284-LLS, ECF No. 476, Slip Op. (Bankr. D. Del. Oct. 3, 2017).
This article was originally published in the December 2017 edition of the Business Reorganization Committee Newsletter. Participation in ABI's committees is one of the many benefits of becoming a member. Committees provide networking and leadership opportunities. For additional information on how you could become involved in ABI and our Committees please visit membership.abi.org.