Unless the Third Circuit or the Supreme Court decides otherwise, bankruptcy courts in Delaware have constitutional authority to issue non-consensual, third-party releases of non-bankruptcy claims along with confirmation of a chapter 11 plan.
In an opinion on September 21, Chief District Judge Leonard P. Stark of Delaware abandoned the insinuation he made 18 months ago, adopted the analysis of Bankruptcy Judge Laurie Selber Silverstein from one year ago and held that the principles of Stern v. Marshall, 131 S. Ct. 2594 (2011), do not apply because confirming a reorganization plan with releases is not tantamount to a final judgment on the merits of non-bankruptcy claims.
Alternatively, Judge Stark held that the appeal from the Millennium Lab Holdings II LLC confirmation order was equitably moot because the plan had been consummated and releases could not be revoked without upsetting the plan as a whole. Judge Stark also reached the merits and held that the releases were proper because Judge Silverstein correctly applied Third Circuit criteria.
The Facts
Millennium Lab Holdings II LLC, the chapter 11 debtor, had obtained a $1.825 billion senior secured credit facility and used $1.3 billion of the proceeds before bankruptcy to pay a special dividend to shareholders.
Indebted to Medicare and Medicaid for $250 million that it could not pay, Millennium filed a chapter 11 petition along with a prepackaged plan calling for the shareholders to contribute $325 million in return for releases of any claims that could be made by the lenders. The plan did not allow the lenders to opt out of the releases.
Before confirmation, a lender holding more than $100 million of the senior secured debt filed suit in district court in Delaware against the shareholders and company executives who would receive releases under the plan. The suit alleged fraud and RICO violations arising from misrepresentations inducing the lenders to enter into the credit agreement.
Over objection, Judge Silverstein confirmed the plan in late 2015 and approved the third-party releases. The dissenting lender appealed.
Millennium filed a motion to dismiss the appeal on the ground of equitable mootness, because the plan had been consummated in the absence of a stay pending appeal.
District Judge Stark’s Remand
On appeal in district court, the objecting lender contended that the bankruptcy court lacked constitutional power to enter a final order granting third-party releases. Judge Stark’s decision in March 2017 could have been read to imply, without holding, that granting the releases was beyond the bankruptcy court’s constitutional power to enter a final order because the releases were “tantamount to resolution of those claims on the merits against” the lender.
Rather than rule on the constitutional issue, Judge Stark remanded the case for Judge Silverstein to decide whether she had final adjudicatory authority, either as a matter of constitutional law or as a consequence of the lender’s waiver. To read ABI’s discussion of Judge Stark’s opinion, click here.
Judge Silverstein’s Opinion Following Remand
On October 3, 2017, Judge Silverstein handed down an impassioned, 69-page opinion concluding that the limitations on the constitutional power of a bankruptcy court under Stern are inapplicable to granting third-party releases because a confirmation order exclusively implicates questions of federal bankruptcy law and raises no issues under state or common law.
Judge Silverstein also analyzed the record and concluded that the objecting lender never raised the constitutional question during or even after confirmation. Citing the prohibition of sandbagging in Wellness International Network, Ltd. v. Sharif, 135 S. Ct. 1932 (2015), Judge Silverstein said that the lender could not lie in the weeds and raise constitutional infirmities for the first time on appeal. On the ground of waiver alone, Judge Silverstein found that she was entitled to enter a final order. To read ABI’s discussion of Judge Silverstein’s opinion, click here.
The objecting lender appealed again to Judge Stark.
The Bankruptcy Court’s Confirmation Power Is Unimpaired
Judge Stark’s 42-page opinion on September 21 contains a meticulous analysis of Judge Silverstein’s decision and a detailed recitation of the parties’ arguments. He upheld Judge Silverstein’s conclusion that the bankruptcy court had constitutional power to approve third-party releases in a confirmation order. He also granted the motion to dismiss other issues in the appeal on the ground of equitable mootness.
Alternatively, Judge Stark reviewed the merits and ruled that the releases were proper under Third Circuit authority.
As he had done before, Judge Stark said it was proper to consider the constitutional issue before entertaining the motion to dismiss for equitable mootness.
On the constitutional issue, Judge Stark said that Stern was inapposite. In the case before the Supreme Court, the bankruptcy judge had conducted a bench trial and ruled on the merits of a counterclaim under state law. Persuaded by Judge Silverstein’s opinion on remand, Judge Stark said that she “determined only that the bankruptcy-specific standards for approving nonconsensual releases in a plan were satisfied.”
Judge Stark adopted Judge Silverstein’s narrow reading of Stern. He said the Supreme Court did not address any context other than counterclaims, nor did it “‘announce a broad holding addressing every facet of the bankruptcy process,’” quoting Judge Silverstein. To determine the applicability of Stern, he said that the “operative proceeding” was plan confirmation, where the bankruptcy court has final adjudicatory power. He explained that approving the releases did not entail an analysis of the merits of the lender’s non-bankruptcy claims.
Because he decided the merits of the constitutional issue, Judge Stark did not decide, one way or another, whether the lender had waived the Stern question.
Turning to equitable mootness, Judge Stark said that the Third Circuit requires analysis of whether the plan has been substantially consummated and whether granting relief on appeal would “fatally unscramble the plan” or significantly harm third parties.
Substantial consummation was not an issue. However, the lender contended that the appellate court could grant relief without unscrambling the plan. The lender wanted Judge Stark to strike the releases only with respect to its claims and otherwise leave the plan intact.
Rejecting the argument, Judge Stark said that striking the release only as to the lender “would severely undermine the Plan and necessarily harm third parties.” He said that the releases “cannot equitably be excised as they were the very centerpiece of the plan.” They were, he said, “the inducement for the Equity Holders’ $325 million contribution, and without this contribution, there could not have been a reorganization.”
He said it would be inequitable were he to allow the lender to sue while also permitting the lender to retain the plan distribution made possible with the contribution from the released parties.
Judge Stark concluded that the plan was equitably moot because it was “unclear” to him “what other practicable relief” he could give the objecting lender.
Finally, Judge Stark examined the merits of the releases, as though he had ruled that the appeal was not equitably moot and the bankruptcy court lacked power to issue a final order with releases.
Because the debtor had indemnified the released parties, Judge Stark said the bankruptcy court had subject matter jurisdiction to issue the releases because there was a conceivable effect on the estate. In view of the bankruptcy court’s “extensive findings upon the substantial and uncontroverted record,” he said that releases were permissible under Third Circuit precedent.