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Oct 15, 2018

We, the Releasees (Redux): Delaware District Court Holds That Bankruptcy Court Had Constitutional Authority to Approve Nonconsensual Third-Party Releases

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On September 21, 2018, the United States District Court for the District of Delaware issued a decision holding that the Bankruptcy Court had constitutional authority to approve the nonconsensual third-party releases contained in the debtor’s plan of reorganization. The District Court also dismissed as equitably moot all other issues raised on appeal by the appellant in connection with the confirmation order. This decision provides helpful guidance regarding the frequently discussed issue of whether there is constitutional authority for a Bankruptcy Court to grant third-party releases in the aftermath of the United States Supreme Court’s decision in Stern v. Marshall.

Background

As described in our prior client alert on this case, the plan of reorganization (the “Plan”) for Millennium Lab Holdings II, LLC, et al. 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 bankruptcy 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 was unconstitutional based upon the U.S. Supreme Court’s decision in Stern v. Marshall.[1]

The Bankruptcy Court entered the confirmation order over the objection of the Opt-Out Lenders, who argued, among other things, that the Bankruptcy Court lacked the constitutional authority to issue a third-party release. Voya, one of the Opt-Out Lenders, appealed to the United States District Court for the District of Delaware.[2] The Debtors filed a motion to dismiss the appeal as equitably moot. The District Court declined to rule on the mootness issues raised in the motion to dismiss, but instead denied the motion to dismiss and remanded the case to the Bankruptcy Court to consider whether it had constitutional adjudicatory authority to approve the nonconsensual third-party release of direct non-bankruptcy claims against the non-debtor equity holders.

On October 3, 2017, the Bankruptcy Court issued an opinion holding 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 concluded that the operative proceeding to consider for purposes of the constitutional analysis is not the non-bankruptcy law claims, but instead the confirmation of the Plan, which unquestionably is a core proceeding. 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. The Bankruptcy Court “reject[ed the Opt-Out Lenders’] 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, and which would, if accepted, dramatically change the division of labor between the bankruptcy and district courts.”

On October 16, 2017, the Opt-Out Lenders again appealed, and also sought to reassert the issues it had raised in its earlier appeal. The Debtors again moved to dismiss the appeal on the basis of equitable mootness.

Decision

The District Court affirmed the remand opinion with respect to the Bankruptcy Court’s constitutional authority to approve the Plan releases. Voya contended that the relevant inquiry for constitutional authority is not whether plan confirmation is core, but rather whether the other proceedings that are implicated by the confirmation order are core. The District Court disagreed with Voya’s contention and instead sided with Judge Silverstein’s ruling that the relevant proceeding before the Bankruptcy Court was plan confirmation, and not each and every proceeding that may be affected by plan confirmation. Moreover, with respect to the argument that the Bankruptcy Court’s confirmation order—which approved the Plan’s releases—was an improper adjudication on the merits of Voya’s non-bankruptcy law claims, the District Court agreed with the Bankruptcy Court’s statement 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.”

Having concluded that no constitutional defect exists with respect to the Bankruptcy Court’s ruling, the District Court next turned to the question of whether Voya’s appeal should be dismissed as equitably moot.[3] Both sides agreed the Plan had been substantially consummated prior to the appeal being heard.

At the outset, the District Court considered whether the fact that Voya sought a stay pending appeal from the Bankruptcy Court, but did not seek a stay from the District Court, should weigh in favor of dismissal of the appeal on equitable mootness grounds. The District Court concluded that, although Voya would have been wise to seek a stay from the District Court in order to stop the prospect of equitable mootness in its tracks, its statutory right to appeal is not premised upon its doing so.

The District Court then looked to the next step in the equitable mootness analysis, i.e. whether granting the relief requested would require undoing the plan (as opposed to modifying it in a manner that does not cause its collapse). The District Court also considered the extent to which a successful appeal, by altering the plan or otherwise, would harm third parties who had acted reasonably in reliance on the finality of plan confirmation.

Considering these factors, the District Court concluded that the appeal meets the criteria for equitable mootness. The District Court agreed with the Debtors that the releases contained in the Plan cannot equitably be excised, as they are the very centerpiece of the Plan. The Bankruptcy Court made a specific finding that the releases were the inducement for a $325 million contribution by certain equity holders, and without this contribution, there could not have been the reorganization from which the Opt-Out Lenders benefitted. Moreover, if the Plan were to be unwound, third parties who reasonably relied on confirmation would suffer injury, as even the Opt-Out Lenders conceded that third parties have engaged in “myriad transactions” pursuant to the Plan. The District Court was not persuaded that, as a practical matter, it could limit its relief solely to striking the releases related to the Opt-Out Lenders’ non-bankruptcy law claims. Instead, because the Bankruptcy Court found that those releases were central to the Plan, which finding was strongly supported by uncontroverted evidence in the record, the District Court stated that taking the releases out of the Plan necessarily would lead to the unraveling of the Plan.

Discussion

In yet another post-Stern decision, a district court within the Third Circuit has held that a Bankruptcy Court has constitutional adjudicatory authority to approve third-party releases in the context of a plan of reorganization. It remains to be seen how the United States Court of Appeals for the Third Circuit will rule on this issue.

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]  The Opt-Out Lenders also filed a motion for stay pending appeal, which stay motion was denied by the Bankruptcy Court.
[3]  The District Court described equitable mootness as a judge-made abstention doctrine which finds applicability in the limited context of an appeal following the confirmation of a plan of reorganization by a bankruptcy court. Notwithstanding an aggrieved party’s statutory right to appeal, and a federal court’s “virtually unflagging obligation” to exercise the jurisdiction conferred on it, in some circumstances, granting the relief requested in the appeal would disrupt the effected plan or harm third parties. Parties seeking to dismiss an appeal as equitably moot contend that even if the implemented plan might be imperfect, granting the relief requested in the appeal would cause more harm than good. For additional information regarding the concept of equitable mootness, please click here to review our recent client alert regarding the Ninth Circuit Jefferson County decision.

Authors and Contributors

Fredric Sosnick

Partner

Financial Restructuring & Insolvency

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Solomon J. Noh

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Joel Moss

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Ned S. Schodek

Partner

Financial Restructuring & Insolvency

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New York