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Stern Challenge to Third-Party Plan Releases Fails in Delaware

In hindsight, it seems inevitable that constitutional and other jurisdictional problems would arise when Congress, in enacting the Bankruptcy Reform Act of 1978, created impressive new powers and responsibilities for the bankruptcy courts (along with a considerable degree of independence) but denied them the status of Article III courts under the Constitution (by denying its judges lifetime tenure, as Article III requires).  And it didn’t take long for the problems to arise.

Almost immediately, litigants began to challenge the constitutionality of non-Article III courts exercising some of the extensive powers that the Reform Act vested in them.  By 1982, the Supreme Court was grappling with the issues and necessarily constraining some of the bankruptcy courts’ powers to conform to constitutional limits.[1]  Congress also was forced to deal with the mismatch of powers and status it had created by enacting a series of patches, especially to the provisions of Title 28 dealing with the bankruptcy courts.[2]  By the 1990s a degree of stability had been achieved, although maintained, it seemed at times, by paper clips and chewing gum.

That stability was shaken by a jurisprudential earthquake, Stern v. Marshall, 564 U.S. 462 (2011), an idiosyncratic case that upset one of the components of the structure that had been fashioned during the 1980s and 1990s by court decisions and rules and by amendments to the Bankruptcy Code and Title 28.  Soon virtually every jurisdictional principle that had previously seemed to be reasonably settled was being challenged in light of Stern

It may also have been inevitable that Stern-based constitutional challenges would get mixed up with another perpetually front-burner issue, “a matter of some controversy: the approval of nonconsensual third-party releases (i.e., the involuntary extinguishment of a non-debtor third party’s claim against another non-debtor, third party) as part of a Chapter 11 plan of reorganization.”[3]  Because Section 524(e) of the Code provides that “discharge of a debt of the debtor does not affect the liability of any other entity on . . . such debt” and for other reasons, it was an uphill struggle early on to obtain approval for non-consensual third-party releases of non-debtors in reorganization plans, but eventually several (but not all) circuits developed criteria for third-party releases that could be included in plans that would be confirmed as consistent with the Bankruptcy Code.[4]

Stern-based challenges to third-party releases in plans contend that only Article III courts have the constitutional authority to release a claim of one non-debtor against another non-debtor (if such a release is permissible at all over the opposition of the holders of the released claims), and, therefore, a reorganization plan containing such a release may be confirmed, if at all, only by a district court, not a bankruptcy court.  These challenges were complicated by the fact that Stern was not self-interpreting.  Courts, counsel and commentators have not developed a national consensus on the proper scope of Stern, perhaps as shape-shifting a decision as any the Supreme Court has issued in this century.

Stern-based challenges to jurisdiction and constitutional authority were asserted in the District of Delaware, venue of many important Chapter 11 cases, in the cases of Millennium Lab Holdings II, LLC and its affiliates.[5]  A group of creditors objected to confirmation of the debtors’ plan by the bankruptcy court on the ground, among others, that Stern and its progeny deprived the court of its constitutional authority to approve the releases of four equity holders that were funding the plan.  The bankruptcy court overruled the creditors’ objection, found that the releases contained in the plan satisfied the Continental criteria and confirmed the plan.

On appeal, the district court remanded the case to the bankruptcy court “to consider whether, or clarify its ruling that, the Bankruptcy Court had constitutional adjudicatory authority to approve the nonconsensual release of Appellants' direct . . . claims against the Non-Debtor Equity Holders . . . .”[6]  On remand, the bankruptcy court produced an extremely thorough analysis and defense of its constitutional authority to confirm a plan containing third-party releases.[7]

The objecting creditors appealed again, and the district court, frankly admitting that, despite its concerns and doubts expressed in the Millennium First District Court Opinion, it had been persuaded by the bankruptcy court’s analysis on remand, affirmed. 

The [District] Court agrees with [the bankruptcy court’s] observation regarding the real nature of this dispute: ‘[t]aking the position that third party releases in a plan are equivalent to [a constitutionally] 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 [under Stern] be entered by a district court.’ [citation omitted]  [The appealing creditors’] real disagreement is with the Third Circuit’s precedent in [Continental] which, like many circuits, concluded that third party releases may be approved when certain standards are met.  [The appealing creditors’] constitutional arguments fail.[8]

The objecting creditors filed a notice of appeal to the Third Circuit on October 3.

 

[1]  See, e.g., Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982).  The constitutional status of the bankruptcy courts produced disputed issues throughout the early years of the Code on a range of issues.  See, e.g., Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989)(whether the bankruptcy courts had the constitutional power to conduct jury trials).

[2]  See, e.g., Bankruptcy Amendments and Federal Judgeship Act of 1984.

[3]  Opt-Out Lenders v. Millennium Lab Holdings II, LLC, 2018 U.S. Dist. LEXIS 162249, at *4 (D. Del. Sept. 21, 2018)(hereinafter, “Millennium Second District Court Decision”).

[4]  E.g., Deutsche Bank AG, London Branch v. Metromedia Fiber Network, Inc., 416 F.3d 136 (2d Cir. 2005); Gillman v. Continental Airlines, 203 F.3d 203 (3d Cir. 2000)(hereinafter, “Continental”); see also our November 9, 2017 blog post, Non-Consensual Third-Party Releases in Chapter 11 Plans: a Recent Decision.

[5]  In re Millennium Lab Holdings II, LLC et al., No. 15-12284 (LSS) (Bankr. D. Del.).

[6]  Opt-Out Lenders v. Millennium Lab Holdings II, LLC, 242 F. Supp. 3d 322, 340 (D. Del. 2017)(hereinafter, “Millennium First District Court Decision”).

[7]  In re Millennium Lab Holdings II, LLC, 575 B.R. 252 (Bankr. D. Del. 2017).  The procedural history is set forth in greater detail in the Millennium Second District Court Decision.  Bankruptcy Judge Silverstein’s opinion on remand defies brief summarization; a copy is attached for interested readers.

[8]  Millennium Second District Court Decision at *36.