Given the “exceptional facts” of the case, the Third Circuit upheld the constitutional power of a bankruptcy court to grant nonconsensual, third-party releases.
Indeed, the circumstances were exceptional. The chapter 11 plan of Millennium Lab Holdings II LLC gave nonconsensual releases to shareholder defendants in return for their $325 million contribution. In his December 19 opinion, Circuit Judge Kent A. Jordan said, “we are not broadly sanctioning the permissibility of nonconsensual third-party releases in bankruptcy reorganization plans.”
Rightly or wrongly, the opinion will give ammunition to those who oppose releases broadly granted for simply participating in a reorganization. Having focused on the constitutional authority of bankruptcy courts to grant nonconsensual releases, the appeals court did not reach the merits, because Judge Jordan ruled that the appeal was equitably moot once he had resolved the constitutional issue.
Strictly speaking, the appeals court therefore did not define circumstances when third-party releases are appropriate, nor did it opine on whether the releases in the particular case were permissible under the Bankruptcy Code or Third Circuit precedent.
The Facts
The case has gone up on appeal, down, and back up again, each time adding more definition to the propriety of third-party releases in Delaware and the Third Circuit.
The 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, the debtor 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 who financed the $1.825 million loan. The plan did not allow the lenders to opt out of the releases.
Before confirmation, lenders 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, Bankruptcy Judge Laurie Selber Silverstein of Delaware confirmed the plan in late 2015 and approved the third-party releases. The dissenting lenders appealed.
The debtor 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 the first appeal in district court, the objecting lenders contended that the bankruptcy court lacked constitutional power to enter a final order granting third-party releases. The decision by Chief District Judge Leonard P. Stark of Delaware 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
In October 2017, Bankruptcy Judge Silverstein wrote an impassioned, 69-page opinion concluding that the limitations on the constitutional power of a bankruptcy court under Stern v. Marshall, 564 U.S. 462 (2011), 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.
Judge Stark’s Second Opinion
In an opinion in September 2018, District Judge Stark abandoned the insinuation he made 18 months earlier, adopted the analysis of Bankruptcy Judge Silverstein, and held that the principles of Stern 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 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. To read ABI’s discussion of Judge Stark’s second opinion, click here.
The dissenting lenders appealed to the Third Circuit. The appeal was argued in September.
Constitutional Power
Judge Jordan did not reach the merits in his 36-page opinion for the Third Circuit. He dealt with two issues: (1) the constitutional authority of a bankruptcy court to grant third-party releases, and (2) whether the appeal was equitably moot.
On the constitutional issue, Judge Jordan dissected Stern and offered insights into the Supreme Court’s opinion. He observed that the high court did not decide whether a bankruptcy restructuring entails a public right that by itself would vest authority in an Article I tribunal.
Instead, Judge Jordan focused on what he characterized as a “two-part disjunctive test” from Stern. The bankruptcy court would have power to grant nonconsensual releases if the action “stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.” Stern, 564 U.S. 462 at 499. [Emphasis added by Judge Jordan].
Focusing on the case at hand, Judge Jordan said that the releases would pass constitutional muster if they involved “a matter integral to the restructuring of the debtor-creditor relationship.”
Turning to the facts, Judge Jordan said the releases were constitutionally appropriate because there would have been no reorganization and no plan confirmation absent the $325 million contributed by the shareholders in return for releases.
Judge Jordan admitted that the dissenting lender’s argument about opening the floodgates to third-party release was “not without force.” He said that demands for releases by “reorganization financers . . . could lead to gamesmanship.”
Judge Jordan said that the decision “should not be read as expanding bankruptcy court authority” nor as “permitting or encouraging . . . hypothetical gamesmanship.” The appeals court, he said, was “not broadly sanctioning the permissibility of nonconsensual third-party releases in bankruptcy reorganization plans.”
Judge Jordan went on to say that the opinion should not “be construed as reducing a court’s obligation to approach the inclusion of nonconsensual third-party releases or injunctions in a plan of reorganization with the utmost care and to thoroughly explain the justification for any such inclusion.”
In sum, Judge Jordan upheld the bankruptcy court’s constitutional power because “the release provisions were integral to the restructuring [and the bankruptcy court’s conclusion] was well-reasoned and well-supported by the record.”
Equitable Mootness
Having found that the bankruptcy court had power to grant releases, Judge Jordan turned to the question of equitable mootness. He recited the familiar two-part test: (1) Has the plan been substantially consummated, and (2) would granting relief to the appellant fatally unscramble the plan or significantly harm third parties who justifiably relied on confirmation?
Judge Jordan quickly concluded that granting relief to the dissenting lenders “would certainly unscramble the plan,” because the releases were “central” to the plan and represented consideration for the shareholders’ $325 million contribution. Even exposing the shareholders to the lenders’ $100 million claim, he said, “would completely undermine the purpose of the release provision.”
Capping off his discussion of mootness, Judge Jordan said that the dissenting lenders want “all of the value of the restructuring and none of the pain. That is a fantasy and upends the purpose of the equitable mootness doctrine, which is designed to prevent inequitable outcomes.”
Consequently, Judge Jordan did not reach the merits because he decided that the district court did not abuse its discretion in ruling that the appeal was equitably moot.
Observations
There are two questions the Supreme Court has not answered: (1) Is equitable mootness a viable doctrine in bankruptcy, and (2) do bankruptcy courts have constitutional or statutory power to grant nonconsensual, third-party releases? With regard to third-party releases, there is a longstanding circuit split.
The Fifth, Ninth and Tenth Circuits hold that third-party releases are categorically impermissible. Other circuits — like the Second, Third, Fourth and Seventh Circuits — permit releases under differing standards.
The dissenting lenders could file a petition for certiorari to raise the viability of equitable mootness, but there is not an evident circuit split. The Supreme Court has shown a reluctance to tackle chapter 11 issues in the absence of a split when the system is otherwise functioning smoothly.
On third-party releases, the dissenting lenders could pursue Supreme Court review on two issues: (1) Did the bankruptcy court have constitutional power under Stern, and (2) even if there was power, does the Bankruptcy Code authorize such releases, and if so, under what circumstances?
It is arguable whether there is a split on the first question, but there surely is on the second.
However, the Third Circuit did not squarely rule on the propriety of third-party releases under the Bankruptcy Code or the appeals court’s existing authority. The case is therefore not a particularly good vehicle for a certiorari petition to raise the circuit split where some appeals courts categorically bar non-debtor releases.
Nonetheless, we will report if the dissenting lenders file a petition for certiorari.
Given the “exceptional facts” of the case, the Third Circuit upheld the constitutional power of a bankruptcy court to grant nonconsensual, third-party releases.
Indeed, the circumstances were exceptional. The chapter 11 plan of Millennium Lab Holdings II LLC gave nonconsensual releases to shareholder defendants in return for their $325 million contribution. In his December 19 opinion, Circuit Judge Kent A. Jordan said, “we are not broadly sanctioning the permissibility of nonconsensual third-party releases in bankruptcy reorganization plans.”
Rightly or wrongly, the opinion will give ammunition to those who oppose releases broadly granted for simply participating in a reorganization. Having focused on the constitutional authority of bankruptcy courts to grant nonconsensual releases, the appeals court did not reach the merits, because Judge Jordan ruled that the appeal was equitably moot once he had resolved the constitutional issue.
Strictly speaking, the appeals court therefore did not define circumstances when third-party releases are appropriate, nor did it opine on whether the releases in the particular case were permissible under the Bankruptcy Code or Third Circuit precedent.