In Brief: Bankruptcy Court Rules That It Has Constitutional Authority to Grant Nonconsensual Releases in Chapter 11 Plan

by Jones Day
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Jones DayIn In re Millennium Lab Holdings II, LLC, 2017 BL 354864 (Bankr. D. Del. Oct. 3, 2017), the U.S. Bankruptcy Court for the District of Delaware ruled that it had the constitutional authority to grant nonconsensual third-party releases in an order confirming the chapter 11 plan of laboratory testing company Millennium Lab Holdings II, LLC ("Millennium"). In so ruling, the court rejected an argument made by a group of creditors that a provision in Millennium’s plan releasing racketeering claims against the debtor’s former shareholders was prohibited by the U.S. Supreme Court’s 2011 ruling Stern v. Marshall, 564 U.S. 462 (2011), which limited claims that can be finally adjudicated by a bankruptcy judge. Bankruptcy judge Laurie Selber Silverstein wrote that the objecting creditors’ position was unsupported and would "dramatically change the division of labor between the bankruptcy and district courts."

In December 2015, the bankruptcy court confirmed Millennium’s chapter 11 plan. The plan released claims against various nondebtor entities, including Millennium’s former shareholders, who contributed $325 million to the estate, in part to fund a $250 million settlement with federal regulators on False Claims Act claims that had to be paid within weeks to avoid forfeiture of Millennium’s Medicare billing privileges.

A group of creditors led by Voya Investment Management ("Voya"), which asserted racketeering claims against the shareholders on the basis of allegations of disclosure failures and conflicts related to a $1.8 billion pre-bankruptcy dividend recapitalization, objected to confirmation. Voya contended, among other things, that the court did not have subject matter jurisdiction to grant nonconsensual third-party releases and that the plan releases did not satisfy the Third Circuit’s decision in Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d. 203, 214 (3d Cir. 2000), which requires specific factual findings that proposed releases are fair and necessary to a reorganization.

The court overruled the objections, and Voya appealed the confirmation order. It argued on appeal, among other things, that the bankruptcy court lacked authority to grant the releases under Stern because barring the racketeering claims was tantamount to adjudicating them, which is outside a bankruptcy court’s constitutional jurisdiction. The district court remanded the constitutionality issue to the bankruptcy court.

On remand, Judge Silverstein rejected Voya’s "expansive reading of Stern, which not only applies Stern outside of the narrow context in which it was made, but far beyond the holding of any court." In Stern, the Supreme Court ruled that a bankruptcy court cannot enter a final judgment on a state law counterclaim of the bankruptcy estate which is not resolved in the process of ruling on a creditor’s proof of claim.

According to Judge Silverstein:

Stern did not hold, as Voya suggests, that regardless of which articulated (or unarticulated) core proceeding is before the court, the bankruptcy judge cannot, consistent with the Constitution, enter a final order in that proceeding if that order affects a party’s entitlement to have a debtor’s or trustee’s state law claim heard by an Article III court.

She also noted that Voya’s Stern-based argument was misplaced because, among other reasons, the racketeering claims were federal and, although the releases undeniably "impacted" the racketeering claims, they did not actually adjudicate them, but were part of a settlement that would give the shareholders an affirmative defense in any racketeering litigation.

Judge Silverstein emphasized that Voya’s interpretation of Stern would "dramatically change the division of labor between the bankruptcy and district courts." She explained that, without consent, which could be withheld as leverage, district courts would be compelled to enter final orders approving a wide range of relief traditionally granted by bankruptcy courts, including orders approving free-and-clear asset sales under section 363, substantive consolidation, and the recharacterization or subordination of claims.

Finally, Judge Silverstein ruled that Voya forfeited any challenge on Stern grounds by failing to make it during the plan confirmation process.

Voya appealed the decision on October 16, 2017.

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Jones Day
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