Millennium II: Third Party Releases Still Constitutionally Viable?

In business reorganizations under chapter 11, third-party releases are important tools that often facilitate consensual plans of reorganization, greater recovery for creditors, and an expedited resolution of bankruptcy cases, particularly where a debtor faces mass tort claims. However, as the bankruptcy courts’ constitutional authority to grant nonconsensual third-party releases in chapter 11 becomes subject to further attack under Stern v. Marshall,[1] the established utility of using bankruptcy as a means to efficiently manage and resolve mass tort claims is increasingly at risk. This issue was recently examined in In re Millennium Lab Holdings II, LLC.[2]

A Brief Background on Stern and Its Progeny

In 2011, the U.S. Supreme Court issued its well-known opinion in Stern. While most practitioners are now familiar with the facts of Stern, it is important to understand that the opinion stems from the Supreme Court’s 1982 ruling in Northern Pipeline Construction Company v. Marathon Pipe Line Company,[3] wherein the Supreme Court held that Congress’s broad grant of authority to bankruptcy courts in § 241(a) of the Bankruptcy Act of 1978 “impermissibly removed most, if not all, of ‘the essential attributes of the judicial power’ from Art[icle] III district courts, and has vested those attributes in a non-Art[icle] III adjunct.”[4] Simply put, Marathon stands for the proposition that “Congress may not vest in a non-Article III court the power to adjudicate a traditional contract action arising under state law.”[5] Because Marathon’s holding rendered the entire jurisdictional grant under the Bankruptcy Act unconstitutional, it led to the Bankruptcy Amendments and Federal Judgeship Act of 1984, which created the modern bankruptcy jurisdiction structure.

Fast-forward nearly 30 years later to Stern, and the Supreme Court similarly held that although the Bankruptcy Code statutorily designated counterclaims as “core bankruptcy proceeding[s],”[6] constitutional principles of separation of powers nonetheless precluded Article I bankruptcy judges from entering final orders on at least some state law counterclaims asserted by a debtor/trustee against a creditor of a bankruptcy estate.[7] Chief Justice Roberts remarked with respect to Marathon: “Substitute ‘tort’ for ‘contract,’ and [Marathon’s reasoning] directly covers this case.”[8]

Some courts have utilized a “narrow interpretation” of Stern, finding that it “stands for the sole proposition that a bankruptcy judge ‘lacked constitutional authority to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor’s proof of claim.’”[9] For example, courts have held under this interpretation that bankruptcy courts can issue final orders on equitable subordination claims,[10] preference and fraudulent transfer claims,[11] certain common law claims,[12] the confirmation of chapter 11 plans,[13] the sale of property of the estate[14] and the approval of substantive consolidation.[15] On the other side of the spectrum, courts adopting the “broad interpretation” have held that Stern prevents final orders on state law fraudulent conveyance claims,[16] fraudulent transfer claims,[17] preference actions[18] and free-and-clear sale orders.[19] In sum, the commonly accepted practices and expectations in chapter 11 reorganizations may hang on the ultimate interpretation of Stern’s scope outside of adversary proceedings. This also includes the bankruptcy court’s ability to resolve mass tort claims through third-party releases and channeling injunctions.

However, the Supreme Court, starting with Stern itself, has issued opinions that approach the Article III question from a narrow, practical standpoint, as opposed to a broad opinion like Marathon. For example, in Executive Benefits Insurance Agency v. Arkison,[20] the Supreme Court held that a bankruptcy court can “issue proposed findings of fact and conclusions of law to be reviewed de novo by the district court” on Stern claims, a practice already adopted by many courts.[21] Further, the Supreme Court’s decision in Wellness International Network Ltd. v. Sharif[22] attempted to resolve Stern issues through the concept of “consent,” as determined by lower courts.[23] While certain Bankruptcy Rules impacting adversary proceedings were amended to address Wellness, these amendments left courts to determine “consent” under Wellness outside of adversary proceedings.[24] Indeed, the issue of consent that divides the Circuit Courts of Appeals may ultimately prove to be the dispositive issue in the third-party release debate under Stern.

Third-Party Releases and Mass Tort Claims

A “third-party release” is a provision in a chapter 11 plan that releases claims of certain nondebtor parties against other nondebtor parties. There are several benefits of third-party releases in chapter 11 bankruptcy cases, especially where a debtor faces mass tort claims. In general, the bankruptcy system is uniquely equipped to efficiently manage mass tort litigation because of its streamlined and flexible procedures that can efficiently resolve a large number of complex claims. For example, bankruptcy courts often enter injunctions discharging all claims against the debtor and channel claims to a post-confirmation trust specifically for tort claimants, enabling debtors to timely obtain their “fresh start” notwithstanding the threat of mass tort claims. A recent high-profile example of this is in the bankruptcy case of Takata Corp.’s U.S. operations,[25] where the bankruptcy court confirmed a plan creating a trust to channel claims relating to the debtor’s allegedly defective airbags.[26] The confirmed plan further granted releases to several nondebtor entities, including certain manufacturers who contributed to the trust.[27] In the confirmation order, the Court applied the Third Circuit Court of Appeals’ standard for approving third-party releases and held that the releases under the plan were fair and necessary to the proposed reorganization and were supported by fair, sufficient and adequate consideration provided by the released parties.[28] While Stern arguments were not raised in the Takata proceedings, Takata serves as a recent example of the utility and importance of third-party releases in modern chapter 11 practice.

While almost all courts have generally enforced “consensual” third-party releases, the majority of the Circuit Courts of Appeals approve the enforceability of “non-consensual” third-party releases in certain limited and appropriate situations. The enforceability of these releases has been determined on a case-by-case basis, often focusing on the nature of the reorganization and whether the released party substantially contributed to the debtor’s reorganization.[29] Nonetheless, many courts have found that bankruptcy cases involving third parties who contribute substantial assets to a trust for the benefit of mass tort claimants are the most appropriate cases to allow nonconsensual releases.[30] Indeed, this is the fundamental premise behind the statutorily authorized ability of bankruptcy courts to release third parties and channel claims with respect to asbestos tort claims.[31]

In re Millennium Lab Holdings II LLC

In Millennium, the debtors’ chapter 11 plan provided for a global resolution of claims, including releases of both debtor and third-party claims against the nondebtor equityholders.[32] The U.S. Bankruptcy Court for the District of Delaware entered an order confirming the plan, which certain lenders appealed.[33]

On March 20, 2017, the U.S. District Court for the District of Delaware remanded the case to the bankruptcy court to consider whether it had constitutional adjudicatory authority to approve the nonconsensual release of nonbankruptcy claims against the nondebtor equityholders.[34]

On remand, the bankruptcy court held that it had constitutional authority to approve the nonconsensual third-party releases.[35] Considering Stern, the bankruptcy court concluded that it had constitutional authority to enter final orders confirming plans containing nonconsensual releases because “the operative proceeding for purposes of a constitutional analysis is confirmation of a plan,” which is an enumerated core proceeding under 28 U.S.C. § 157(b).[36] The bankruptcy court held that an order confirming a plan containing third-party releases “does not rule on the merits of the state law claims being released and therefore does not implicate Stern.”[37] Any holding otherwise may require district courts to enter final orders in a variety of matters, including, among other things, § 363 asset sales, substantive consolidation, and re-characterization and/or subordination of claims.[38] The lenders appealed the ruling to the district court, where the appeal is currently pending. Oral argument on the appeal of the bankruptcy court’s remand ruling is currently set for July 13, 2018.

The Impact of Stern and Millennium on Third-Party Releases and Mass Tort Claims

In remanding Millennium, the district court commented that the lenders “appear to be entitled to Article III adjudication of [their] claims under Stern.” Many commentators predicted that nonconsensual third-party releases may no longer be an available tool in chapter 11 practice.[39] However, the bankruptcy court’s decision on remand appears to preserve the viability of these releases. Millennium’s outcome is very important, as nonconsensual third-party releases are a significant part of the plan-negotiation process and often provide direct, fair contributions to mass tort claimants in a designated trust — much more so than the “substantial contribution” of a nondebtor released party to the overall plan itself, which creditors merely benefit from as a part of the general creditor body.

However, in light of Stern and its progeny, which increasingly focus on practical solutions to address “narrow” constitutional issues and avoid the chaos left in the wake of broader opinions like Marathon, the creation of trust funds for mass tort claimants arguably present the best, practical argument for supporting bankruptcy courts’ continued ability to approve third-party releases. Practitioners should have some hope that the appellate courts will take a similar practical approach when faced with these questions.