Delaware District Court finds that Bankruptcy Court Cannot Enter a Final Order Releasing Third-party Claims Without Constitutional Authority

by Cole Schotz
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In this post-Stern opinion (the “Opinion”), the United States District Court for the District of Delaware (the “Court”) addresses two main issues with respect to the approval of nonconsensual third-party releases provided for in a chapter 11 plan of confirmation, namely whether a Bankruptcy Court has (1) subject matter jurisdiction to approve, and (2) the constitutional authority to grant such releases. Opinion at 2. The Court handed down its decision on March 17, 2017, over a year after the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) entered its order confirming Millennium Lab Holdings II, LLC, and its affiliated debtors’ (the “Debtors”) chapter 11 confirmation plan that contained such nonconsensual third-party releases. However, the decision is not, as one might had hoped for, a clarification as to whether a bankruptcy court has the authority to enter a final order approving such releases. Instead, recognizing that this is “far from ideal at this stage of the Chapter 11 proceedings,” the Court remanded the case to the Bankruptcy Court to give it an opportunity to address the issue of adjudicatory authority first.  Id. at 28.

Background

The Debtors’ chapter 11 plan provided, among other things, for a large contribution by non-debtor equity holders. Id. at 9. In exchange for the $325 million contribution, the plan contained certain nonconsensual third-party releases providing certain non-debtor equity holders “with full releases and discharges of any and all claims against them and related parties . . . . ”  Id. Importantly, the plan did not provide for an opt-out mechanism, therefore automatically, and regardless of whether creditors consented, granting the releases upon confirmation of the plan. Id. at 9-10.

Prior to the plan confirmation, certain pre-petition lenders (the “Appellants”) filed suit against the non-debtor equity holders alleging, among other things, fraud and violation of RICO claims. Id. at 10. The Appellants further objected to confirmation of the plan on multiple grounds. Id. They asserted, among other things, that the Bankruptcy Court lacked subject matter jurisdiction, and even if it had subject matter jurisdiction, it lacked the statutory authority to approve the third-party releases. Id. at 11.  After the Bankruptcy Court entered the order approving the chapter 11 plan on December 11, 2015, the Appellants filed an appeal raising several issues, but arguing primarily that “the release and permanent injunction of their direct, non-bankruptcy claims against non-debtors is a final order” prohibited by Stern and Wellness. Id. at 19-20.

A more detailed background of the Millennium Lab Holdings II, LLC, et al., bankruptcy cases and the history of the appeal can be found here.

Stern and Wellness

Before addressing the particularities of the case before it, the Court revisited the holdings of Stern and Wellness, two recent Supreme Court decisions that address the Bankruptcy Court’s jurisdictional authority.  Id. at 2-7 (citing Stern v. Marshall, 131 S. Ct. 2594 (2011); Wellness Int’l Network, Ltd. V. Sharif, 135 S. Ct. 1932, 1938-39 (2015)). The Court noted that these cases make “clear . . . that parties have a constitutional right to have their common law claims adjudicated by an Article III court, and [that] that right cannot be abridged by Congressional action.” Opinion at 3. The Court further noted that, “Article III imposes a structural limitation on the power of an Article I court to enter final orders or judgments on state law claims without the parties’ consent.” Id. at 2. The Court explained that Bankruptcy Courts “may ‘enter appropriate orders and judgments’ only in ‘cases under title 11’ and ‘core proceedings arising under title 11, or arising in a case under title 11.’” Id. at 3 (citing 28 U.S.C. Section 157(b)(1)).  In a non-core proceeding, that is “related to” a bankruptcy case, the Court clarified that the Bankruptcy Court’s authority, absent consent of the parties, is limited to hearing the matter and submitting proposed findings of fact and conclusions of law to an Article III District Court. Id. at 3-4.

Subject Matter Jurisdiction and Adjudicatory Authority Post-Stern

The Court, after briefly summarizing the law as to whether the permanent release of a non-debtor, third-party’s claim against another non-debtor third party falls under the purview of “related-to,” “arising in,” or “arising under” title 11 jurisdiction, the Court agreed with the Bankruptcy Court’s holding that such a release falls under the Bankruptcy Court’s “related-to” subject matter jurisdiction.  Id. at 4-5. However, having found that the Bankruptcy Court had subject matter jurisdiction did not end the inquiry for the Court. Id. at 19 (“The impact of Stern is that a finding of ‘related to’ subject matter jurisdiction under the statute does not end the inquiry.”). The Court held that “regardless of whether the Bankruptcy Court has subject matter jurisdiction over proceedings – both core and non-core – it cannot enter a final order releasing third-party claims unless it has constitutional authority to do so as well.” Id. at 7.

The critical question of adjudicatory authority, however, was not addressed by the Bankruptcy Court in its bench ruling confirming the Debtors’ chapter 11 plan. Id. at 14.  With respect to subject matter jurisdiction, Judge Silverstein noted:

The holding in Stern was meant to be a narrow one; one that does not, quote, “meaningfully change the division of labor between the Bankruptcy Court and the District Court.” To this end, debtors cite cases rejecting a Stern challenge, regarding the Bankruptcy Court’s constitutional authority to consider approval of third-party releases in a plan, including Judge Drain’s decision in MPM Silicones, but not any decision in this district. These Courts may be correct.  But because of the necessities of this case, I have not had time to address that argument.  But I need not do so, given my finding that I have related-to jurisdiction.  Having decided I have jurisdiction, I now turn to whether third-party releases are appropriate in this case . . . .

Id. at 14 (quoting 12/11/15 Bankruptcy Court Hr’g. Tr. at 15:23-16:11 [D.I. 206]).

As a result, the District Court, noting that “the Bankruptcy Court’s confirmation ruling . . . did not address whether the Bankruptcy Court lacked adjudicatory authority to enter a final order releasing those claims,” remanded the case to the Bankruptcy Court to, “given its experience and expertise, . . .  rule on this issue first.” Opinion at 14, 28.

On April 4, 2017, the Bankruptcy Court held a status conference and has requested briefing on the issue of constitutional authority in 45 days with an additional three-week reply deadline. See Vince Sullivan, Millennium to Brief Court on Creditor 3rd-Party Releases, Law360 (Apr. 4, 2017, 8.35 PM), https://www.law360.com/articles/909920/millennium-to-brief-court-on-creditor-3rd-party-releases. Judge Silverstein was quoted to have said that “[a]ssuming I don’t decide to strike releases, then I think that there may be the necessity of proposed findings of fact and conclusions of law.” Id. at 3.

Stay tuned.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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