United States: We, The Releasees: Delaware Bankruptcy Court Holds That It Had Constitutional Authority To Approve Nonconsensual Third-Party Releases

On October 3, 2017, Bankruptcy Judge Laurie Selber Silverstein of the United States Bankruptcy Court for the District of Delaware issued a decision holding that the Bankruptcy Court had constitutional authority to approve third-party releases in a final order confirming a plan of reorganization. The Bankruptcy Court determined that, even though the confirmation order directly impacted the adjudication of the merits of certain non-bankruptcy common law claims, it's power to enter the confirmation order was not limited by the United States Supreme Court's decision in Stern v. Marshall, which held that bankruptcy courts lack the constitutional authority to enter final judgments on state law counterclaims. In reaching its decision, the Bankruptcy Court observed that a conclusion that it lacked the power to enter a confirmation order with third-party releases would "dramatically change the division of labor between the bankruptcy and district court . . . ." As a result, the bankruptcy bar has greater certainty (for now) that Delaware Bankruptcy Courts have both constitutional and statutory authority to approve third-party releases which may be integral to confirmation of a plan and the debtor's restructuring efforts. 

Background

On December 14, 2015, the Delaware Bankruptcy Court entered an order confirming the plan of reorganization of Millennium Lab Holdings II, LLC and certain affiliates. The Plan provided for third-party releases in favor of various non-debtor entities, including certain non-debtor equity holders who contributed hundreds of millions of dollars to the estate as part of a settlement contained in the Plan.

At the confirmation hearing, certain lenders under the Debtors' senior secured credit facility (the "Opt Out Lenders") objected to the Plan's release of certain claims that creditors might assert against non-debtor equity holders. Specifically, the Opt Out Lenders argued that granting the releases, which essentially would foreclose the adjudication of those non-bankruptcy common law claims, was unconstitutional based on the Supreme Court's decision in Stern1. The Bankruptcy Court entered the confirmation order over the objection of the Opt Out Lenders, who then appealed to the United States District Court for the District of Delaware. On remand, the District Court asked the Bankruptcy Court to consider whether it had constitutional adjudicatory authority to approve the nonconsensual third-party release of direct non-bankruptcy common law claims against the non-debtor equity holders. 

Decision

The Bankruptcy Court held that a bankruptcy judge does indeed have constitutional adjudicatory authority to confirm a plan containing nonconsensual third-party releases of non-bankruptcy claims. The Bankruptcy Court stated that the operative proceeding to consider for purposes of the constitutional analysis is not the common law non-bankruptcy claims, but instead is confirmation of the Plan, which unquestionably is a core proceeding.2 Moreover, unlike the counterclaim in Stern, the confirmation of a plan, even one containing releases of non-bankruptcy claims against non-debtor entities, requires a bankruptcy judge to apply federal standards and interpret federal law.3

The Bankruptcy Court held that entry of a final order confirming the Plan does not violate the Supreme Court's decision in Stern, even though it may have a preclusive effect on a third-party lawsuit outside of the bankruptcy proceeding. As Judge Silverstein noted, "[a]n order confirming a plan with releases does not rule on the merits of the state law claims being released. . . [instead], a ruling approving third party releases is a determination that the plan at issue meets the federally created requisites for confirmation and third party releases." Although there are various interpretations of Stern, some narrow (i.e., view the power of the bankruptcy court expansively) and some broad (i.e., view the power of the bankruptcy court most restrictively),4 the Bankruptcy Court found that bankruptcy judges have authority to enter final orders confirming plans containing nonconsensual releases even under the broadest interpretation of Stern, as the confirmation of a plan requires application of federal law.

Discussion

Contrary to the Opt Out Lenders' argument, the Millennium Bankruptcy Court found that Stern does not stand for the proposition that, simply because a party files an action in a district court, it has an absolute right to have the merits of its claims determined in the context of that civil litigation rather than by a bankruptcy court. As Judge Silverstein noted, taking such a view would mean that no bankruptcy court could ever enter an order impacting a non-bankruptcy action (e.g., district courts would be compelled to enter the final order approving any asset sale where a purchaser seeks to be free of successor liability, as well as any order approving substantive consolidation or recharacterization, to name a few). Indeed, the Supreme Court itself emphasized the narrowness of its ruling in Stern, stating that it should not meaningfully change the division of labor between bankruptcy and district courts, and Judge Silverstein's decision here declines to extend Stern beyond what the Supreme Court expressly intended to be a narrow holding. Notably, the District Court's remand was specific to the question of the Bankruptcy Court's constitutional authority to approve the nonconsensual releases; the District Court never decided, and expressly left open, the question of whether courts have the power to grant nonconsensual third-party releases as a general matter (constitutional objections aside). The Opt Out Lenders have filed an appeal of the Bankruptcy Court's decision in Millennium.  

Footnotes

1 In Stern, the Supreme Court held that the Bankruptcy Court lacked the constitutional authority to enter a final judgment on a state law counterclaim that was not resolved in the process of ruling on a creditor's proof of claim. For more detail on the Stern decision, click here to see our prior client alert on the topic.

2 Bankruptcy cases and civil proceedings arising in and arising under title 11 are "core" proceedings, while civil proceedings related to cases under title 11 are "non-core." Bankruptcy judges can both hear and enter final orders in core proceedings (subject to appeal to the district court). On the other hand, bankruptcy judges can only hear, but not determine, non-core proceedings, meaning that the judge must enter proposed findings of fact and conclusions of law for review by the district court. 

3 A confirmed plan, and the releases contained therein, must satisfy the applicable provisions of the Bankruptcy Code. 

4 The narrow interpretation of Stern stands for the sole proposition that a bankruptcy judge lacks constitutional authority to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor's proof of claim. The broad interpretation of Stern is not limited to counterclaims, and stands for the proposition that a bankruptcy judge cannot enter a final judgment on any state law claims, any common law based causes of action (including even actions such as fraudulent transfer claims in situations where the relevant defendant has not filed a proof of claim) or any causes of action under state law. In either case, Stern is limited to claims based on state law that are commenced in the context of traditional civil litigation.

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