Nonconsensual third-party releases continue to attract attention in the busiest business bankruptcy forums in the country. In a long-anticipated opinion, In re Millennium Lab Holdings II, LLC, 945 F.3d 126 (3d Cir. 2019), the U.S. Court of Appeals for the Third Circuit upheld a bankruptcy court decision confirming a chapter 11 plan containing nonconsensual third-party releases. The Third Circuit has not yet given such releases its wholesale approval—this opinion simply held that the bankruptcy court's order confirming the plan did not violate Article III of the U.S. Constitution. In fact, the Third Circuit made sure to emphasize the limited nature of its holding. With this ruling, however, the Third Circuit has finally weighed in on an important—although rarely discussed—aspect of the nonconsensual third-party release framework.
Validity of Nonconsensual Third-Party Releases in Chapter 11 Plans
The circuit courts of appeals are split as to whether a bankruptcy court has the authority to approve chapter 11 plan provisions that, over the objection of creditors or other stakeholders, release specified nondebtors from liability and/or enjoin dissenting stakeholders from asserting claims against such nondebtors. The minority view, held by the Fifth, Ninth, and Tenth Circuits, bans such nonconsensual releases on the basis that they are prohibited by section 524(e) of the Bankruptcy Code, which provides generally that "discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt." See Bank of N.Y. Trust Co. v. Official Unsecured Creditors' Comm. (In re Pac. Lumber Co.), 584 F.3d 229 (5th Cir. 2009); In re Lowenschuss, 67 F.3d 1394 (9th Cir. 1995); In re W. Real Estate Fund, Inc., 922 F.2d 592 (10th Cir. 1990); see also Zacarias v. Stanford International Bank Ltd., 945 F.3d 883 (5th Cir. 2019) (third parties making substantial contributions to the receiver in the R. Allen Stanford Ponzi scheme are entitled to an order barring creditors from suing on the creditors' claims), petition for rehearing en banc denied, No. 17-11073 (5th Cir. Jan. 21, 2020).
By contrast, the majority of the circuits that have considered the issue—the Second, Fourth, Sixth, Seventh, and Eleventh Circuits—have found such releases and injunctions permissible under certain circumstances. See In re Drexel Burnham Lambert Grp., Inc., 960 F.2d 285 (2d Cir. 1992); In re A.H. Robins Co., Inc., 880 F.2d 694 (4th Cir. 1989); In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002); In re Airadigm Commc'ns, Inc., 519 F.3d 640 (7th Cir. 2008); SE Prop. Holdings, LLC v. Seaside Eng'g & Surveying, Inc. (In re Seaside Eng'g & Surveying, Inc.), 780 F.3d 1070 (11th Cir. 2015). For authority, these courts generally rely on section 105(a) of the Bankruptcy Code, which authorizes courts to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]." Moreover, as the Seventh Circuit held in Airadigm, the majority view is that section 524(e) does not limit a bankruptcy court's authority to grant such releases.
The First and D.C. Circuits have suggested that they agree with the "pro-release" majority. See In re Monarch Life Ins. Co., 65 F.3d 973 (1st Cir. 1995) (a debtor's subsidiary was collaterally estopped by a plan confirmation order from belatedly challenging the jurisdiction of the bankruptcy court to permanently enjoin lawsuits against the debtor's attorneys and other nondebtors not contributing to the debtor's reorganization); In re AOV Indus., 792 F.2d 1140 (D.C. Cir. 1986) (a plan provision releasing liabilities of nondebtors was unfair because the plan did not provide additional compensation to a creditor whose claim against the nondebtor was being released; adequate consideration must be provided to a creditor forced to release claims against nondebtors). The Third Circuit declined to decide the issue in In re Continental Airlines, 203 F.3d 203 (3d Cir. 2000), ruling that a plan release provision did not pass muster under even the most flexible tests for the validity of nondebtor releases.
Majority-view courts employ various tests to determine whether such releases are appropriate. Factors generally considered by courts evaluating third-party plan releases or injunctions include whether they are essential to the reorganization, whether the parties being released have made or are making a substantial financial contribution to the reorganization, and whether affected creditors overwhelmingly support the plan. See Dow Corning Corp., 280 F.3d at 658 (listing factors).
The Third Circuit had another opportunity to weigh in on the validity of nondebtor plan releases in Millennium.
In 2014, laboratory testing company Millennium Lab Holdings II, LLC ("Millennium") entered into a $1.8 billion credit agreement with lenders. Millennium then used the proceeds from the credit agreement to refinance existing debt and to pay a nearly $1.3 billion special dividend to its shareholders.
In 2015, following a federal investigation, Millennium reached a $256 million settlement with the Department of Justice, Medicare, and Medicaid regarding alleged violations of various laws. Shortly thereafter, Millennium concluded that it was unable to pay this settlement amount while also servicing its debt obligations under the 2014 credit agreement. Millennium then filed a chapter 11 petition in the District of Delaware, along with a prepackaged plan providing for prepetition shareholders to contribute $325 million in return for releases of claims by Millennium's lenders. The plan did not permit the lenders to opt out of the releases.
One of the lenders, Voya Investment Management Co. LLC ("Voya"), objected to confirmation of the plan. Voya intended to sue prepetition shareholders and company executives for alleged misrepresentations made as part of the 2014 financing transaction. Voya argued that the bankruptcy court did not have subject matter jurisdiction to approve nonconsensual third-party releases. Bankruptcy judge Laurie Selber Silverstein overruled Voya's objections and confirmed the plan. Voya appealed the confirmation order, arguing on appeal that the bankruptcy court lacked constitutional authority to order the releases. In addition, shortly after confirmation, Voya sued the prepetition shareholders in federal district court, alleging racketeering, fraud, and related claims. Voya's district court suit was stayed pending the appeal of the confirmation order.
The District Court Remand. The appellees, all of whom were named as released parties in the confirmed plan, moved to dismiss on the basis that the appeal was equitably moot because, among other things, Millennium's chapter 11 plan had been substantially consummated and granting the relief sought by Voya would lead to profoundly inequitable results. Chief judge Leonard P. Stark of the U.S. District Court for the District of Delaware remanded the case below, directing the bankruptcy court to consider whether it had constitutional authority to confirm a plan releasing Voya's claims in light of the U.S. Supreme Court's decision in Stern v. Marshall, 564 U.S. 462 (2011). In Stern, the Supreme Court articulated a "disjunctive test" for whether a bankruptcy court can enter a final order on a state law counterclaim of the bankruptcy estate: "Congress may not bypass Article III [of the U.S. Constitution] simply because a proceeding may have some bearing on a bankruptcy case; the question is whether the action at issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process." Stern, 564 U.S. at 499 (emphasis added). The Court ruled that a bankruptcy court cannot enter a final judgment on a state law counterclaim of the bankruptcy estate that is not resolved in the process of ruling on a creditor's proof of claim.
The district court's remand decision in Millennium thus appeared to question whether the bankruptcy court had constitutional power to enter a final order because the releases were "tantamount to resolution of those claims on the merits."
The Bankruptcy Court's Opinion on Remand. On remand, Judge Silverstein concluded that Stern is inapplicable when the proceeding at issue is confirmation of a chapter 11 plan. And even if Stern did apply, the bankruptcy court said, Stern's limitations would be satisfied. Voya appealed this second decision to the district court, and Millennium again moved to dismiss the appeal as being equitably moot.
The District Court's Second Opinion. The district court agreed that Stern is inapplicable to plan confirmation proceedings and affirmed the bankruptcy court's holding. The district court did not fault the bankruptcy court's conclusion that approval of the chapter 11 plan releases did not amount to adjudication on the merits of Voya's racketeering and related claims. Like the bankruptcy court, the district court noted that Voya's position was at best "a substantive argument against third party releases, not an argument that confirmation orders containing releases must be entered by a district court."
The district court also dismissed the remainder of Voya's appeal as equitably moot because: (i) the releases were central to the plan; (ii) removing the releases would undo the basic deal embodied in the plan; and (iii) Voya should not be permitted to benefit from the restructuring while simultaneously pursuing claims against the prepetition shareholders that such shareholders paid to settle by making a $325 million contribution to Millennium's reorganization. The district court also reasoned that even if it was wrong on these issues, it would still affirm the confirmation order by rejecting Voya's challenges on the merits. Voya appealed to the Third Circuit.
The Third Circuit's Ruling
A three-judge panel of the Third Circuit affirmed the district court's ruling.
Circuit judge Kent A. Jordan wrote for the panel and focused the constitutional analysis on Stern's "two-part disjunctive test." As noted above, the test asks whether the bankruptcy court's ruling "stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process." Stern, 564 U.S. at 499. Therefore, bankruptcy courts may constitutionally decide issues "integral to the restructuring of the debtor-creditor relationship."
Applying these principles, Judge Jordan ruled that the bankruptcy court had constitutional authority to confirm the plan with the release provisions. The record below established that the releases were "critical to the success of the Plan," the releases were "necessary to both obtaining the funding and consummating a plan," and "without [prepetition shareholders'] contributions, there [would be] no reorganization." As a consequence, Judge Jordan had no trouble concluding that the restructuring in Millennium's bankruptcy case "was possible only because of the release provisions."
Voya argued that providing the prepetition shareholders and company executives with releases, against the prepetition lenders' wishes, would open the floodgates to third-party releases. Judge Jordan acknowledged that this argument was "not without force" and that demands for releases by "reorganization financers ... could lead to gamesmanship." In apparent response to such concerns, the judge attempted to limit how widely the court's opinion can be applied. For example, he noted that the opinion "should not be read as expanding bankruptcy court authority" nor as "permitting or encouraging ... hypothetical gamesmanship." Judge Jordan also refrained from endorsing nonconsensual third-party releases wholesale. Consistent with precedent, he wrote, the Third Circuit is "not broadly sanctioning the permissibility of nonconsensual third-party releases in bankruptcy reorganization plans." Indeed, the holding is premised on the "specific, exceptional facts of this case."
The Third Circuit ultimately affirmed the bankruptcy court's constitutional power to approve nonconsensual third-party releases in a plan of reorganization because "the release provisions were integral to the restructuring[, and the bankruptcy court's conclusion] was well-reasoned and well-supported by the record."
The Third Circuit also affirmed the lower courts' ruling that Voya's appeal was equitably moot because, among other things, granting Voya's requested relief—which would, in essence, permit Voya to sue the prepetition shareholders—would "scramble the plan," and any attempt to unwind the plan would likely be impossible.
Observations and Conclusion
The Third Circuit has now determined that a bankruptcy court may approve nonconsensual third-party releases in a chapter 11 plan under the U.S. Constitution. Although the Third Circuit attempted to limit the opinion's applicability, litigants in lower courts are likely to rely on the opinion to bolster arguments in favor of nonconsensual third-party plan releases. Voya filed a petition on March 24, 2020, seeking review of the Third Circuit's decision by the Supreme Court. As the circuit split on third-party releases continues, the likelihood increases that the Court will step in to resolve at least some of the issues that are presented.
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