On September 21, 2018, Judge Leonard Stark of the U.S. District Court for the District of Delaware affirmed Bankruptcy Judge Laurie Selber Silverstein's Oct. 3, 2017, remand opinion with respect to the bankruptcy court’s constitutional authority to approve nonconsensual third-party releases in the Millennium health debtors’ prepackaged plan of reorganization.  The releases encompassed, among other things, the Millennium opt-out lenders’ direct non-bankruptcy common law fraud and RICO claims against Millennium’s former equityholders. Judge Stark also dismissed all remaining issues raised on appeal as equitably moot and, alternatively, affirmed the confirmation order with respect to those remaining issues.

After hearing oral argument on July 12, the district court had reserved decision on the appeal filed by the opt-out lenders, a group of funds advised by Voya, as well as the reorganized debtors’ motion to dismiss the appeal as moot.

Background

Under the plan, which became effective in December 2015, Millennium’s equityholders made a $325 million contribution in connection with a settlement with the U.S. Department of Justice in exchange for third-party releases. Despite the opt-out lenders’ objection to the plan’s releases of the equityholders, the bankruptcy court confirmed the plan and the opt-out lenders appealed the confirmation.

In March 2017, the district court remanded the case to the bankruptcy court for further proceedings to consider or clarify whether the bankruptcy court had constitutional adjudicatory authority to release the lenders’ RICO and state-law fraud claims against Millennium prepetition equityholders. In October 2017, the bankruptcy court issued the opinion that is the subject of the instant appeal, finding that it does indeed have such authority.

Opinion

Relying on the U.S. Supreme Court’s decision in Stern v. Marshall, the Opt-Out Lenders argued on appeal that the Bankruptcy Court lacked constitutional authority to confirm the plan containing the release.  The crux of the Opt-Out Lenders’ argument was the preclusive effect that the release would have on the continuing prosecution of the RICO lawsuit, which they argued should be the focal point of the Stern analysis.  However, the District Court found this argument to be unpersuasive and instead agreed with the Bankruptcy Court that plan confirmation is the “operative proceeding” and that the applicable Stern test did not have to be applied in the context of plan confirmation.  Judge Stark agreed with Judge Silverstein’s conclusion that “ determining whether a bankruptcy court has constitutional authority to issue a final order on a proceeding requires looking at the proceeding – here, the confirmation plan proceeding – not on its incidental effects – which, here, would be its impact on [the Opt-Out Lenders’] RICO/fraud claims.”  Moreover, in its conclusion that the Opt-Out Lenders’ constitutional arguments fail, the District Court again agreed with the Bankruptcy Court’s observation that “[t]aking the position that third party releases in a plan are equivalent to an impermissible adjudication of the litigation being released is, at best, a substantive argument against third party releases, not an argument that confirmation orders containing releases must be entered by a district court.”           

Not finding any “constitutional defect” with respect to the Bankruptcy Court’s decision, Judge Stark opined that striking the plan’s release would “severely undermine the Plan and necessarily harm third parties.”  Unwinding the plan at this stage would, according to the District Court, injure third parties that reasonably relied on plan confirmation and engaged in subsequent transactions pursuant to the terms of the plan.         

To the extent that the District Court “reached contrary conclusions on constitutional authority and/or equitable mootness,” it would also alternatively affirm the confirmation order “by rejecting on the merits the other issues raised on appeal by [the Opt-Out Lenders].”  The District Court ultimately concluded that the Opt-Out Lenders’ arguments “provide no basis to disturb the Bankruptcy Court’s conclusion that the Plan releases were necessary to the reorganization and fair.”

If claims over which a bankruptcy court has no independent jurisdiction could be transformed into proceedings within the bankruptcy court’s jurisdiction by simply including their release in a proposed plan, bankruptcy courts could acquire limitless jurisdiction and would end-run the ruling in Stern.  To allow this type of “back-door” adjudication of non-bankruptcy related claims could potentially lead to plans that ultimately violate Stern.  This expansive reading of Stern could provide leverage for other chapter 11 debtors to abrogate constitutional limitations and extinguish non-debtor claims in a plan without the objecting creditor’s consent.