Third party releases have long been a controversial feature of certain chapter 11 plans. They are neither specifically allowed nor prohibited by the plain language of the Bankruptcy Code. This has led courts to reach differing results. There are two important principles at play in these cases. On the one hand, bankruptcy exists to provide relief to debtors. On the other hand, bankruptcy plans are intended to provide the greatest possible return to creditors. If granting releases makes the plan possible, this is in the best interest of creditors.
The Third Circuit waded into this debate to answer a very limited question: does Article III permit non-consensual third party releases? The Court's answer, at least in the specific case before it, was yes. In re Millenium Holdings II, LLC, 945 F.3d 126 (3rd Cir. 12/19/19).
What Happened
Millenium was a lab testing company. It borrowed $1.8 billion to refinance certain debts and pay a $1.3 billion special dividend to its shareholders. The government decided to revoke the debtor's billing privileges under Medicare following an investigation. Millenium agreed to pay the government $256 million. However, this left it unable to pay its debts. When the lenders were asked to restructure their debts, they asked some hard questions about the related party transactions and the disclosures that were made in connection with the loans. (Editor's note: This was a $1.8 billion transaction. How did the lenders miss the weaknesses in the house of cards?).
Most of the lenders reached a restructuring support agreement with the debtor and its affiliates. Under the deal, the affiliates would pay the debtor $325 million and transfer their equity to the lenders. In return, they would receive complete releases. The deal was the result of extensive adversarial negotiations over a period of time. The Third Circuit found that "the deal to avoid corporate destruction would not have been possible without the third-party releases." Opinion, p. 9.
Although 93% of the lenders agreed to the deal, one did not. Millennium filed a Prepackaged Joint Plan of Reorganization. Voya, one of the the hold out lenders, objected. The Bankruptcy Court confirmed the Plan and Voya appealed. The District Court remanded the case to Bankruptcy Court for a determination of whether the plan violated Stern v. Marshall. The Bankruptcy Court said it did not and the District Court affirmed.
The Issues on Appeal
The Third Circuit limited its review to two issues:
1. Did the Bankruptcy Court have constitutional authority to confirm the plan?
2. If the Court had authority, was the appeal equitably moot?
The Third Circuit answered yes to both questions and affirmed the lower courts.
So why those two issues? If the Bankruptcy Court lacked constitutional authority to confirm the plan, jts order would not be a final judgment capable of being appealed. Instead, it would have had to be sent to the District Court for de novo review. On the other hand, if the Bankruptcy Court had authority to enter the order and the appeal was equitably moot, there would be nothing remaining for the court to review.
Constitutional Authority
When the Supreme Court decided Stern v. Marshall, 564 U.S. 462 (2011), many commentators feared that it would imperil the functioning of the Article I Bankruptcy Courts. (Article I Courts are those established by the legislative branch and whose judges are not confirmed by the Senate and do not have life tenure). However, despite Chief Justice Roberts's desire to bring more control to the Article III Courts, the existing structure soldiered on with a few tweaks.
The Debtors and Voya made absolutist arguments to the Court. The Debtors claimed that Bankruptcy Courts always have constitutional authority to confirm a plan. Voya, on the other hand, argued that the Bankruptcy Court only had constitutional authority to decide matters necessary to adjudicating claims. It argued that granting the third party releases constituted an adjudication of its RICO and fraud claims which could only be done by an Article III Court.
The Court of Appeals cautioned in a footnote that the Debtors' argument may be too expansive and it explicitly rejected Voya's argument as putting the cart before the horse. The Court of Appeals stated that:
To Voya, that point is irrelevant. Voya contends that Stern demands an Article III adjudicator decide its RICO/fraud claims because those claims do not stem from the bankruptcy itself and would not be resolved in the claims-allowance process. It asserts that the limiting phrase from Stern, i.e., "necessarily be resolved in the claims allowance process[,]" cannot be stretched to cover all matters integral to the restructuring. (Opening Br. at 31.) In that regard, Voya argues that an assertion that something is "integral to the restructuring" is really "nothing more than a description of the claims allowance process." (Reply Br. at 13.)
That argument fails primarily because it is not faithful to what Stern actually says. Had the Stern Court meant its "integral to the restructuring" language to be limited to the claims-allowance process, it would not have said that a bankruptcy court may decide a matter when a "creditor has filed a claim, because then" — adding its own emphasis to that word — "the ensuing preference action by the trustee become[s] integral to the restructuring of the debtor-creditor relationship." 564 U.S. at 497 (alteration in original). That phrasing makes clear that the reason bankruptcy courts may adjudicate matters arising in the claims-allowance process is because those matters are integral to the restructuring of debtor-creditor relations, not the other way around. And, as the Appellees correctly observe, Stern is not the first time that the Supreme Court has so indicated. In Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 109 S. Ct. 2782,106 L. Ed. 2d 26 (1989) — a case that the Stern Court viewed as informing its Article III jurisprudence, 564 U.S. at 499 — the Court answered first whether an action arose in the claims-allowance process and only then whether it was otherwise integral to the restructuring of debtor-creditor relations. See Granfinanciera, 492 U.S. at 58 ("Because petitioners here ... have not filed claims against the estate, respondent's fraudulent conveyance action does not arise 'as part of the process of allowance and disallowance of claims.' Nor is that action integral to the restructuring of debtor-creditor relations."). If the first step in that analysis were all that was relevant, the second step would not have been taken.945 F,3d at 137-139. Reducing the issue to its most basic, Bankruptcy Courts have authority to enter final orders on matters integral to the restructuring of debtor-creditor relations. The fact findings of the Bankruptcy Court made clear that the third party releases were integral to the plan, which was a restructuring of the debtor-creditors relations. Therefore, the Bankruptcy Court had constitutional authority to confirm the plan and Voya's main argument failed. (Author's note: One thing that fascinates me about reading judicial opinions is how a few paragraphs out of a long opinion can carry the crux of the whole opinion. This is just such a case).
Equitable Mootness Wraps Up the Case
The Third Circuit made clear that it was not endorsing broad third party releases. However, it did not reach the issue of whether such releases were permissible under bankruptcy law due to equitable mootness. Basically, equitable mootness says that if a plan is confirmed and has been substantially consummated, it cannot be set aside where parties have acted in reliance upon it. Equitable mootness will not apply to a discrete part of a controversy which can be set aside and the parties placed back in their status quo position. However, if you can't unscramble the confirmed plan, you can't set it aside. What equitable mootness does is requires a party complaining about a plan to obtain a stay pending appeal or risk losing its appeal. Voya did not do so here and as a result, the court did not reach the merits. The key here is that the third party releases were essential to the plan. Without the third party releases, the insiders would not have funded the plan. Without the insiders funding the plan, there would be no plan.
What It Means
Basically what this case means is take your best shot in the bankruptcy court because you may not have another shot on appeal. Stern v. Marshall is not a talisman which will fend off bankruptcy while equitable mootness makes it really hard to challenge a plan which, as here, was negotiated between multiple parties and involved a lot of moving pieces.
What does this case say about nonconsensual third party releases in general? As a matter of law, it does not say much. However, what it says as a practical matter, is that it will be hard for one obstructive creditor to impede a deal that almost everyone else wants. I will talk about the status of third party releases in general in a subsequent post.
Hat tip to Britt Suttell who pointed me to the opinion.
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