In a significant decision in a closely watched case, Bankruptcy Judge Laurie Selber Silverstein held in In re Millennium Lab Holdings II, Case No. 15-12284 (LSS) (Del. Bankr. Oct. 3, 2017), that the bankruptcy court had constitutional adjudicatory authority to approve the nonconsensual release of nondebtor, direct nonbankruptcy common law claims against third parties as part of a confirmation order. In so doing, she rejected the plan objectors' expansive reading of Stern v. Marshall, 131 S. Ct. 2594 (2011), which, in her opinion, would apply Stern outside of the narrow context in which it was decided, go beyond the holding of any court applying Stern, and dramatically change the division of labor between the bankruptcy and district courts.

The case was before Silverstein on remand from the district court. In an oral ruling, Silverstein had confirmed a plan of reorganization for then-debtors Millennium Lab Holdings and certain of its affiliates which provided for third-party releases in favor of various nondebtor entities, including certain of the debtors' equity holders who had paid money to the estate as part of a settlement contained in the plan. Voya, on behalf of a group of opt-out lenders, objected to the inclusion in the plan of releases of claims that creditors, including Voya, might assert against the nondebtor equity holders and an accompanying bar order and injunction. The day before the confirmation hearing, Voya had filed a complaint asserting RICO and common law fraud claims against those entities in the district court. Voya argued that the bankruptcy court did not have subject matter jurisdiction to grant nonconsensual third-party releases; the third-party releases were impermissible in any event; the plan had to permit parties to opt-out of the releases; and the releases did not meet the standard set by the Third Circuit in Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203 (3d Cir. 2000).

Silverstein rejected Voya's arguments and confirmed the plan, including the nonconsensual third party releases. Voya appealed the order to the district court which, after briefing and argument, remanded the case for further proceedings in the bankruptcy court. The district court found that it was unclear to what extent the bankruptcy court had the opportunity to consider its authority post-Stern to enter a final order discharging Voya's nonbankruptcy claims against nondebtors without its consent, since the matter had not been argued or briefed in the bankruptcy court, and directed the bankruptcy court to consider whether it had constitutional adjudicatory authority to approve the nonconsensual release of Voya's direct, nonbankruptcy common law fraud and RICO claims against third parties.

Silverstein concluded that as a bankruptcy court, she had the constitutional authority to enter a final order confirming plans containing nonconsensual releases. In so doing, she considered the various interpretations of Stern, including the so-called “narrow interpretation,” holding that Stern stands solely for the proposition that a bankruptcy judge lacks constitutional authority to enter a final order on a state law counterclaim that is not resolved in the process of ruling on a creditor's proof of claim; the “broad interpretation,” holding that a bankruptcy judge cannot enter a final judgment on any state law claims, common law causes of action or causes of action under state law; and the “broadest Interpretation,” holding that a bankruptcy judge must consider its ability to enter final orders in all enumerated or unenumerated core proceedings.

Silverstein found that the operative proceeding for purposes of the constitutional analysis was the confirmation of a plan, an enumerated core proceeding under the Bankruptcy Code. Under the narrow interpretation, Stern was inapplicable since confirmation of a plan is not a state law counterclaim that was not resolved in the process of ruling on a creditor's proof of claim. Under the broad interpretation, Stern was inapplicable since confirmation of a plan is not a state law claim of any type.

Under the broadest interpretation, the result was the same. First, confirmation of a plan is a quintessential “core” proceeding. Second, in confirming a plan, even one with releases, the judge is applying a federal standard. In the U.S. Court of Appeals for the Third Circuit, under Continental, the third-party releases must be fair and necessary to the reorganization. In confirming a plan with releases, the bankruptcy judge does not rule on the merits of the state law claims being released. Rather, the judge examines the terms of the plan, the outcome of the solicitation of the plan, and the necessity of the injunction to the success of the plan. Third, there is no state law equivalent to confirmation of a plan. A ruling approving third-party releases is a determination that the plan meets the federally created requisites for confirmation and third-party releases.

Silverstein specifically rejected Voya's argument that under Stern, Article III prevents a bankruptcy court from entering a final judgment disposing of a nonbankruptcy claim against a nondebtor that is not resolved as part of the claim resolution process, regardless of the nature of the proceeding. Stern did not address, either expressly or by implication, any context other than state law counterclaims. It did not announce a broad holding addressing every facet of the bankruptcy process. But even were she to accept Voya's argument, Silverstein said she would find that the RICO lawsuit was resolved in the claims allowance process, since the settlements in the Plan were comprehensive in nature, and provided for payments in exchange for the releases and for the allowance and treatment of claims such as those held by Voya.

Finally, Silverstein rejected Voya's argument that it is unconstitutional for a bankruptcy judge to enter a final order if that order might affect a pending lawsuit filed by a creditor against a third party. She held that Stern does not prevent a bankruptcy judge from entering final orders in statutory core proceedings notwithstanding the orders' collateral impact on state law claims. Reviewing precedent from the Third Circuit and elsewhere, Silverstein concluded that a bankruptcy judge may enter a final order in a core matter that impacts or even precludes a state law action between two nondebtors.

Silverstein noted that adopting Voya's interpretation of Stern would dramatically change the division of labor between the bankruptcy and the district courts. She gave examples of numerous contexts wherein the district courts would be forced to enter final orders if Voya's arguments were adopted, including the sale of assets under Section 363 in which a purchaser seeks to be free of successor liability, stay violation motions in which state law lien rights against third parties are adjudicated, involuntary proceedings in which ownership interests between two non-debtors are adjudicated, substantive consolidation of debtors and/or debtors and non-debtors in which the rights of creditors and non-creditors against non-debtor entities are rearranged, and recharacterization and subordination proceedings in which state law debts are transformed. Stern was not intended to create an alternative framework for ruling on core proceedings interpreting federal law that touch upon state law rights.

Silverstein's decision in Millennium Labs was eagerly awaited by the bankruptcy bar, but is unlikely to be the final word. Voya again has appealed her decision to the district court. However, it is unlikely that the district court will want to use this case to dramatically shift the division of labor in core proceedings between the bankruptcy courts and the district courts. Stern does not compel such a result, and the district court will be reluctant to endorse it. In the meantime, the approval of nonconsensual third-party releases in confirmation plans will continue when necessary to effect a reorganization.

Barry M. Klayman is a member in the commercial litigation group and the bankruptcy, insolvency and restructuring practice group at Cozen O'Connor. He regularly appears in Chancery Court.

Mark E. Felger is co-chair of the bankruptcy, insolvency and restructuring practice group at the firm.