Confirmation in the New Millennium: Stern and a Plan with Non-Consensual Third-Party Releases

Circuits are split on the issue of whether bankruptcy courts can confirm plans containing non-consensual third-party releases. Historically, the split involved the application of Bankruptcy Code § 105 or 524. Recently, however, a few secured creditors have relied on Stern v. Marshall,[1] in which the Supreme Court held that 28 U.S.C. § 157(b)(2)(C) is unconstitutional to the degree it authorizes the bankruptcy court to determine common law compulsory counterclaims that are not necessarily resolved in determining the allowance of a proof of claim, to challenge confirmation of a plan with non-consensual third-party releases.

One such attempt failed. In 2013, in In re St. Charles St. African Methodist Episcopal Church of Boston (“St. Charles”),[2] a secured creditor objected to confirmation of a plan that included the release of a third party’s guaranty. Citing Stern, it argued that approval of the release via confirmation would be “tantamount to adjudication of the guaranty, which, as a two-party dispute that arises under state law between non-debtor parties, cannot constitutionally be adjudicated by a non-Article III judge.”[3] However, the U.S. Bankruptcy Court for the District of Massachusetts rejected this argument, observing that the matter before was “not a suit on the Guaranty ... [but] the confirmation of a plan, a unitary omnibus civil proceeding....”[4] The court reasoned that confirmation “is not an adjudication of the various disputes it touches upon ... [and] is a matter of ‘public rights’ that, under Stern, Congress may constitutionally assign to a non-Article III adjudicator.”[5]

A similar challenge was made in 2015 in In re Millennium Lab Holdings II LLC before the U.S. Bankruptcy Court for the District of Delaware. The Millennium plan included releases of debtor and third-party claims against nondebtor equity-holders. Voya, a lender group, objected and filed a complaint against the non-equity-holders in federal district court, alleging RICO and common law fraud claims. Voya then argued that because the bankruptcy court did not have jurisdiction over the district court claims, it could not order the releases via confirmation. The bankruptcy court entered its confirmation order, over Voya’s objection.

Voya appealed the confirmation order to the district court,[6] where the debtors moved to dismiss for mootness. However, the district court determined that it could not rule on dismissal without first determining whether Stern deprived the bankruptcy court of authority to order the releases. In the district court’s view, the plan’s release was “tantamount to resolution of the claims on the merits”[7] (the opposite view of the St. Charles court). Further, the district court wrote that it “does not agree with Debtors that the Plan release did not run afoul of Stern because it was not a final adjudication of the claims. If Article III prevents the bankruptcy court from entering a final order disposing of a non-bankruptcy claim against a non-debtor outside of the proof of claim process, it follows that this prohibition should be applied regardless of the proceeding....”[8] The district court remanded, with instructions to the bankruptcy court to “consider whether, or clarify its ruling that, it had constitutional adjudicatory authority to approve the nonconsensual release of [the claims],” and if it determines that it does not, then “to issue 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.”[9] Thereafter, the appeal of the confirmation order was closed.

On remand, the bankruptcy court did not share the district court’s Stern concerns. In a lengthy Oct. 3, 2017, opinion, the bankruptcy court concluded it had authority to confirm a plan containing non-consensual third-party releases and rejected “Voya’s expansive reading of Stern, which not only applies Stern outside of the narrow context in which it was made, but far beyond the holding of any court, and which would, if accepted, dramatically change the division of labor between the bankruptcy and district courts.”[10]

The bankruptcy court began by acknowledging Northern Pipeline Constr. Co. v. Marathon Pipe Line Co.,[11] in which the Supreme Court struck down the Bankruptcy Act because it granted to bankruptcy judges powers reserved for Article III judges. However, the bankruptcy court noted that Marathon has not been interpreted to be a death knell for bankruptcy judge authority, citing In re AOV Indus. Inc., in which the U.S. Court of Appeals for the D.C. Circuit observed that Marathon does not “prohibit all bankruptcy court decisions that may have tangential effects. The expansive reading of Marathon urged on us ... would limit the power of these Article I courts to a far greater degree than we believe Congress or the Supreme Court intended.”[12] The Millennium bankruptcy court then observed that Stern “did not change much.”[13] Stern held that the statutory designation of a § 157(b)(2) claim as “core” does not determine whether a bankruptcy judge has constitutional authority to enter a final judgment on that claim. That is, the congressionally created concept of “coreness” does not permit an end-run around the Constitution.

The Millennium bankruptcy court determined that, even applying the broadest interpretation of Stern, a bankruptcy judge still has authority to confirm a plan with non-consensual third-party releases. The court rejected Voya’s arguments, including that confirmation was unconstitutional because it may have a preclusive effect on Voya’s district court claims. The court observed that “[t]here is no state law analogue; third party releases in chapter 11 plans are quintessentially federal in nature.”[14] It also reasoned that to accept Voya’s arguments would dramatically change the division of labor between the bankruptcy and district courts, without a mandate from Stern to do so. In addition, the court concluded that Voya had waived or forfeited any argument that it was entitled to have the district court enter the final order on confirmation.

Voya appealed the opinion to the district court, and the appeal is now pending before the same judge who presided over the appeal of the confirmation order. Depending on the outcome of the appeal, Millennium has the potential to reshape confirmation of plans with non-consensual third-party releases. Voya contends not merely that the bankruptcy court lacks authority to enter a final judgment on confirmation of a plan containing non-consensual third-party releases, but that the constitutional deficit cannot be cured by issuing findings and recommendations on confirmation for the district court’s review. Voya insists that confirmation would be a constitutionally impermissible substitute for an Article III court adjudication on the merits of the claims.