Yes, says the Third Circuit. The Third Circuit recently held that the Bankruptcy Court has the authority to confirm a chapter 11 plan which contains nonconsensual, third-party releases when such releases are integral to the successful reorganization. The court’s decision in In re Millennium holds that, when the third-party releases are integral to the restructuring of the debtor-creditor relationship, the Bankruptcy Court has the constitutional authority to approve nonconsensual, third-party releases.
Following a Federal investigation, the Dept. of Justice (“DOJ”) sued the debtors, Millennium Lab Holdings II and its affiliates (“Millennium”), for violation of various laws, and the Center for Medicare and Medicaid Services (“CMS”) notified Millennium that it would be revoking its billing privileges. To avoid the destruction of its business, Millennium entered into a settlement agreement with the DOJ and CMS agreeing to pay $256 million, of which $50 million was paid as an upfront deposit.
Quickly thereafter, however, Millennium realized that it lacked the liquidity to fund the settlement as well as meet its obligations under its $1.825 billion credit agreement. Negotiations with an ad hoc group of lenders followed. The negotiations, as described by the Court, were “highly adversarial,” “extremely complicated,” at arms-length where the parties were represented by “sophisticated and experienced professionals.” These negotiations eventually resulted in the Restructuring Support Agreement, which was reflected in the debtors’ chapter 11 prepackaged plan of reorganization. The Restructuring Support Agreement provided that the shareholders will contribute $325 million and would transfer 100% of their equity interests to the company’s lenders in exchange for full releases from all claims.
Voya, one of the lenders, objected to the confirmation of the plan because it intended to assert misrepresentation claims against Millennium’s equity holders related to the credit agreement. The Bankruptcy Court overruled Voya’s objection, and Voya challenged the Bankruptcy Court’s decision by arguing it lacked constitutional authority to confirm a plan releasing Voya’s claims against non-debtor third-parties under the Supreme Court’s decision in Stern v. Marshall. The District Court affirmed, and Voya appealed.
The question before the Third Circuit was whether the Bankruptcy Court possessed the constitutional authority to confirm a chapter 11 plan of reorganization which included nonconsensual, third-party releases and injunctions designed to enforce them. Analyzing Stern v. Marshall and the facts of the case, the Third Circuit held that it did.
Stern v. Marshall
In Stern, the Supreme Court continued the evolution of its jurisprudence regarding the scope of, and limitations on the Bankruptcy Court’s constitutional authority. The Third Circuit in Millennium drew three main points from Stern. First, even when the bankruptcy court acts in one of the designated “core proceedings” categories, it may still violate Article III of the Constitution and therefore exceed its constitutional authority. Therefore, concluding that the bankruptcy court proceedings constituted core does not end the matter; the decision still must be reviewed for compliance with Article III.
Second, in Stern, the Supreme Court found that a bankruptcy court can resolve a matter that is integral to the restructuring of the debtor-creditor relationship. Specifically in Stern, the Supreme Court held that the bankruptcy court had authority to decide matters stemming from the bankruptcy itself or that would necessarily be resolved in the claims allowance process.
Third, courts should focus on the content of the proceedings rather than on the category of “core” proceedings at issue. As the Third Circuit explained, Stern did not declare all counterclaims to be beyond the scope of the bankruptcy court’s authority; rather, it held that those counterclaims that do not stem from the bankruptcy, or are not necessarily resolved in the claims allowance process, are not integral to the debtor-creditor relationship.
Applying Stern to the Facts
Turning to the specific facts of the case, the Third Circuit found that the Bankruptcy Court was authorized to confirm a chapter 11 plan containing nonconsensual, third-party releases because the releases were absolutely critical to the successful reorganization of the debtors. The release provisions were highly negotiated and were necessary to the success of the reorganization. Based on the record before it, the Third Circuit concluded that “[a]bsent [the shareholders’] payment, the company could not have paid the government, with the result that liquidation, not reorganization, would have been Millennium’s sole option. Restructuring in this case was possible only because of the release provisions,” and the shareholders were only willing to enter to effectuate the transaction in exchange for the releases. The Third Circuit noted that both the Bankruptcy Court and District Court had found that the “deal to avoid corporate destruction would not have been possible without the third-party releases.” Accordingly, the releases were absolutely integral to a successful reorganization.
Voya’s main argument was that the centrality of the release to the plan was irrelevant because its RICO and fraud claims against the shareholders do not stem from the bankruptcy nor would they be resolved in the claims allowance process. The Court rejected the argument because Stern did not limit matters central to the restructuring only to matters involving the claims allowance process.
Voya’s other challenge rested on the floodgates argument; that a ruling allowing the Bankruptcy Court to approve a nonconsensual, third-party release will be manipulated and abused allowing bankruptcy courts to “approve release simply because [lenders] demand them.” Recognizing that the argument is not without force, the Court cautioned that plans including such releases must meet exacting standards and bankruptcy courts should be cautious in approving them.
The Third Circuit’s decision in Millennium is an important development in understanding the scope of the Bankruptcy Court’s authority under Stern, as well as the conditions that justify a nonconsensual, third-party release in the Third Circuit. We also believe that the opinion will be influential in cases outside the Third Circuit.