Without making a definitive ruling, a district judge in Delaware said that Stern v. Marshall and its progeny preclude a bankruptcy court from entering a final order granting non-consensual third-party releases of non-bankruptcy claims, even as part of a chapter 11 confirmation order.
In his March 17 opinion, District Judge Leonard P. Stark implied that a bankruptcy court must submit proposed findings and conclusions to the district court, which would have the power to enter a final order approving third-party releases contained in a chapter 11 plan.
Judge Stark’s opinion seems to mean that a creditor objecting to confirmation of a plan with third-party releases will have an automatic stay pending appeal while the district court conducts de novo review of the bankruptcy court’s proposed findings and conclusions regarding non-consensual releases.
Judge Stark’s opinion has another important consequence: The district court will review findings on third-party releases de novo and not use the clear-error standard, thus giving a district court theoretically wider latitude to reject releases.
Ruling on appeal from a confirmation order, Judge Stark remanded the case for the bankruptcy court in the first instance to rule on whether it has constitutional authority to enter a final order imposing third-party releases. If the bankruptcy court decides it does not have final adjudicatory authority, Judge Stark instructed the bankruptcy court to submit proposed findings and conclusions.
The Millennium Plan
The appeal arose from the reorganization of Millennium Lab Holdings II LLC, a provider of laboratory-based diagnostic testing services.
While being investigated by Medicare and Medicaid for fraudulent billing, the company obtained a $1.825 billion senior secured credit facility and used $1.3 billion of the proceeds to pay a special dividend to shareholders.
Thirteen months after the loan, the company agreed to settle with Medicare and Medicaid by paying $250 million. Unable to restructure its debt out of court, Millennium initiated a prepackaged chapter 11 reorganization six months later, in part to carry out the settlement.
The plan provided that the shareholders would contribute $325 million in return for releases of any claims that could be made by the lenders. The plan did not contain an opt-out provision allowing lenders to exempt themselves from the third-party releases given the shareholders.
The shareholders’ $325 million contribution would be used to pay the government settlement. Some of the lenders would get $50 million in return for supporting the plan, while the remainder would be used for the reorganized company’s working capital.
Before confirmation, lenders holding more than $100 million of the debt filed suit in district court in Delaware against the shareholders and company executives who would receive third-party releases under the plan. The suit alleged fraud and RICO violations arising from misrepresentations inducing the lenders to enter into the credit agreement. The suit in district court was stayed pending appeal from plan confirmation.
The bankruptcy court confirmed the plan and approved the third-party releases. The dissenting lenders appealed, but the bankruptcy court denied a stay pending appeal. The lenders did not seek a stay from higher courts.
Having consummated the plan, Millennium filed a motion to dismiss the appeal on the ground of equitable mootness. The parties also briefed the merits of the appeal, in which the dissenting lenders alleged that no court in Delaware had ever approved such a broad third-party, non-debtor injunction.
Judge Stark’s Opinion
In connection with the contested confirmation hearing, Judge Stark said the bankruptcy court ruled that it had “related to” jurisdiction to impose third-party releases. He said the bankruptcy judge also ruled that third-party releases were appropriate under Third Circuit authority.
Significantly, Judge Stark reviewed the proceedings in the lower court and concluded that the bankruptcy court had not decided whether it had power under Stern to enter a final order granting the releases.
Judge Stark conceded that the company made a “persuasive” argument that the appeal should be dismissed as equitably moot. Nonetheless, he sided with the dissenting lenders by saying he could not consider equitable mootness “without first determining whether a constitutional defect in the bankruptcy court’s decision deprived that court of the power to issue that decision.”
Turing to the jurisdictional and constitutional issues, Judge Stark agreed that the bankruptcy court had “related to” jurisdiction to issue non-consensual releases. However, he said it was not clear that the bankruptcy court “ever had the opportunity to hear and rule on the adjudicatory authority issue.”
On the Stern question, Judge Stark said that the lenders’ common law fraud and RICO claims involved public rights that were “not closely intertwined with a federal regulatory program.” Consequently, he said, the dissenting lenders “appear entitled to Article III adjudication of these claims.”
Judge Stark said he was “further persuaded” by the lenders’ “argument that the Plan’s release, which permanently extinguished [the lenders’] claims, is tantamount to resolution of those claims on the merits against” the lenders. He rejected the company’s contention that the releases in the plan “did not run afoul of Stern because it was not a final adjudication of the claims.”
Next, Judge Stark said that a de novo review by him would not “resolve the constitutional concerns set forth in Stern.”
Despite what he called the “seeming merits” of the dissenting lenders’ arguments, Judge Stark said he “will not rule on an issue that the bankruptcy court itself may not have ruled upon.”
He therefore remanded the case for the bankruptcy court to consider whether it had “constitutional adjudicatory authority” to approve non-consensual releases of the dissenting lenders’ “direct-bankruptcy common law and RICO claims.” If the bankruptcy court decides it does not have final adjudicatory authority, Judge Stark said the lower court should submit proposed findings and conclusions. Alternatively, Judge Stark said, the bankruptcy court could strike the releases from the confirmation order.
Judge Stark denied the equitable mootness motion without prejudice.
Assuming she feels compelled to issue proposed findings and conclusions, the bankruptcy judge on remand will presumably reach the same factual conclusions and again approve the releases, thus setting up the company to argue once again that the appeal is equitably moot. It is not clear that Judge Stark, the next time around, would dismiss the appeal as equitably moot if he were to differ with the bankruptcy court about the propriety of the releases, because he said that the bankruptcy judge on remand could strike the releases.
Confirmation Becomes Two-Step Process
Assuming Judge Stark is correct and plan releases are not core issues, plans like Millennium’s will require two-step confirmation, first in the bankruptcy court, followed by de novo review in district court of non-consensual releases. Consequently, a plan could not be consummated until after district court review of proposed findings and conclusions about the releases. Presumably, the district court would review the merits of the appeal at the same time.
Given the lack of finality with regard to releases, a dissenter in effect gets an automatic stay of the confirmation order pending appeal to the district court.