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Delaware Bankruptcy Court Finds It Has Constitutional Adjudicatory Authority to Enter a Final Confirmation Order Containing Nonconsensual Third Party Releases

In re Millennium Lab Holdings II, LLC, No. 15-12284 (LSS), 2017 WL 4417562 (Bankr. D. Del. Oct. 3, 2017), aff’d by Opt-Out Lenders v. Millennium Lab Holdings II, LLC (In re Millennium Lab Holdings II, LLC), No. 17-1461 (LPS), 2018 WL 4521941 (Bankr. D. Del. Sept. 21, 2018)

Following the United States Supreme Court’s ruling six years ago in Stern v. Marshall, 131 S. Ct. 2594 (2011), the constitutional adjudicatory authority of bankruptcy courts to enter final orders has been challenged in a variety of proceedings, leading to varied interpretations of the reach of the Stern decision.  In Millennium, the Delaware Bankruptcy Court was asked on remand from the Delaware District Court whether it had the constitutional authority to enter a final order confirming a plan that contained nonconsensual third party releases, i.e. releases of claims asserted by a non-debtor party against another non-debtor party.  While bankruptcy courts in the Third Circuit have consistently held that they have subject matter jurisdiction to consider nonconsensual third party releases and that such releases are permitted if the evidentiary record satisfies the standards set forth in Gilman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203 (3d Cir. 2000), and its progeny, the issue of a bankruptcy court’s constitutional authority to grant them with finality is a matter of first impression.  In a lengthy and detailed opinion in which the Honorable Laurie Selber Silverstein examined, among other things, the constitutional adjudicatory authority of bankruptcy courts since the United States Supreme Court’s decision in Northern Pipeline Construction Company v. Marathon Pipe Line Company, 458 U.S. 50 (1982), Her Honor answered the District Court’s question in the affirmative.  According to Judge Silverstein, bankruptcy courts possess the constitutional authority to enter a final order confirming a plan that contains nonconsensual third party releases.  Even if they do not, however, the Court found that the objecting party forfeited and waived its right to assert the Court’s lack of authority under the specific facts and circumstances presented.  All that remains now in this keenly watched matter is the inevitable appeal.

Following Stern, litigants and bankruptcy courts alike have asked: What is a bankruptcy court’s constitutional adjudicatory authority as a non-Article III court to enter a final judgment in a proceeding which is statutorily defined as core under 28 U.S.C. § 157(b) but which does not stem from the bankruptcy proceeding?  In Stern, the proceeding was a debtor’s state law tortious interference counterclaim brought in an adversary proceeding initiated by a creditor alleging defamation damages.  While the counterclaim constituted a core proceeding under 28 U.S.C. § 157(b)(2)(C), the Supreme Court ruled that Article III of the U.S. Constitution precluded the bankruptcy judge from entering a final judgment on the claim.  The counterclaim did not stem from the bankruptcy (it existed under applicable state tort law without regard to the bankruptcy), and it would not necessarily be resolved in the bankruptcy claims allowance process to determine the validity and amount of the creditor’s defamation claim.

As explained by the Bankruptcy Court in Millennium, there have been a range of interpretations of the Stern decision.  Some are narrow, holding that bankruptcy courts cannot “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.”  Op. at 23 (emphasis in original).  Others are broad, holding that bankruptcy courts cannot “enter a final judgment on all state law claims, all common law causes of action or all causes of action under state law[.]”  Id. (emphasis in original).  And some are extremely broad, holding that Stern requires bankruptcy courts to “examine their ability to enter final orders in all enumerated or unenumerated core proceedings[,]” such as confirmation proceedings under 28 U.S.C. § 157(b)(2)(L).  Id. at 25 (emphasis in original).  At its essence, however, Judge Silverstein noted that the Stern decision (and its limitation on bankruptcy courts’ constitutional authority to enter final orders) “is limited to claims based on state law that are commenced in the context of traditional civil litigation, or generically, Debtor/Trustee v. Defendant.”  Op. at 24.

With that framework in place, the Court’s next critical step was to categorize the proceeding before it.  The objecting party argued that the third party claims to be released should be the focus, but the Court disagreed.  Rather, the Court found the operative proceeding to be the confirmation of a plan of reorganization, which is an enumerated core proceeding under 28 U.S.C. § 157(b)(2).  While there is no dispute that this type of proceeding affects claims (including the released claims), the Court held it is not a claim, counterclaim, or an action, and certainty is not an adjudication of the merits of any released claims.  Plan confirmation is a creature unique to the bankruptcy process as is much of the relief contained within a plan, such as third party releases.  As such, the standards of approval of both confirmation and third party releases sound in federal bankruptcy law and, accordingly, Judge Silverstein determined that a bankruptcy judge has the constitutional adjudicatory authority to enter a final confirmation order containing nonconsensual third party releases, a holding consistent with the few courts having already addressed the issue.  See Op. at 21-23 (discussing In re Charles St. Afr. Methodist Episcopal Church of Bos., 499 B.R. 66 (Bankr. D. Mass. 2013) and MPM Silicones, LLC, No. 14-22503 (RDD), 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014)).

However, even assuming the Court did not have the authority to enter a final confirmation order, the Court found that the objecting party forfeited the right to contest Her Honor’s authority to do so by not raising the argument in its objections to confirmation.  Moreover, it waived the right to contest Her Honor’s authority by, among other things, not complying with the Delaware Bankruptcy Court’s Local Rule 9013-1(h) by including a statement in its confirmation objections specifically withholding its consent to the entry of a final confirmation order.  Failure to do so under such rule results in a waiver of the right to contest the Court’s authority to enter final orders and judgments.  See Wellness Int’l Network, Ltd. v. Sharif, 135 S. Ct. 1932 (2015) (holding post-Stern that litigants may consent to a bankruptcy court’s constitutional adjudicatory authority to enter final orders).

[Update – On September 21, 2018, Judge Stark of the Delaware District Court affirmed Judge Silverstein’s opinion with respect to the Bankruptcy Court’s constitutional authority to approve plan releases.  In doing so, the Court agreed that the focus should be plan confirmation rather than the appellants’ RICO/fraud claims and the plan’s incidental effects on them (i.e. their release).  Moreover, Judge Stark was persuaded by Judge Silverstein’s opinion that when a bankruptcy court approves a plan containing third party releases, it applies bankruptcy-specific law, such as sections 1123 and 1129 of the Bankruptcy Code, and does not adjudicate the merits of the  released claims.   Significantly, this departed from His Honor’s statement in the March 2017 remand opinion that the approval of plan releases was tantamount to an adjudication of the released claims on their merits.

In addition to affirming the constitutional decision of Judge Silverstein, Judge Stark affirmed Her Honor’s decision to approve the releases under applicable bankruptcy law and also found the appeal equitably moot given that, among other things, the plan was substantially consummated and the appellants’ request to strike the releases – a centerpiece of the plan – would unravel the reorganization plan and harm third-parties that reasonably relied on the plan’s confirmation.  See Opt-Out Lenders v. Millennium Lab Holdings II, LLC (In re Millennium Lab Holdings II, LLC), No. 17-1461 (LPS), 2018 WL 4521941 (Bankr. D. Del. Sept. 21, 2018)]