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Nonconsensual Third-Party Releases: Using the Bankruptcy Process to Eliminate Claims of Non-Debtors

John Arrastia and Angelo Castaldi


  • The issue of whether bankruptcy courts have the power to effectively release and enjoin claims of creditors against non-debtor entities without the consent of such creditors has led to a split among the circuit courts.
  • With its recent decision in In re Millennium Lab Holdings II, LLC, the U.S. Court of Appeals for the Third Circuit rekindled this controversial issue.
  • This article examines the Millennium Lab decision, analyzes it against the legal framework from which it emanates, and assesses the key takeaways from the decision.
Nonconsensual Third-Party Releases: Using the Bankruptcy Process to Eliminate Claims of Non-Debtors
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Traditionally, a principal aim of the Chapter 11 debtor-in-possession was, and is, to enjoy the benefit of the Bankruptcy Code’s reorganization provisions to restructure its affairs and obtain a discharge of its pre-petition debts through a plan of reorganization. For some time, debtors-in-possession have also sought, with varying degrees of success, to use the bankruptcy process to obtain releases of valuable claims of creditors against non-debtor third parties. This issue of whether bankruptcy courts have the power to effectively release and enjoin claims of creditors against non-debtor entities without the consent of such creditors has led to a split among the circuit courts.

With its recent decision in In re Millennium Lab Holdings II, LLC, No. 18-3210, 2019 WL 6904684 (3d Cir. Dec. 19, 2019), the U.S. Court of Appeals for the Third Circuit rekindled this controversial issue. This article examines the Millennium Lab decision, analyzes it against the legal framework from which it emanates, and assesses the key takeaways from the decision.

The Facts of the Millennium Lab Case

“On the specific, exceptional facts” of the case, the Third Circuit, on December 19, 2019, issued its Millennium Lab decision, holding that the bankruptcy court could confirm a Chapter 11 plan that contained nonconsensual third-party releases and injunctions without violating Article III of the Constitution. Those “specific, exceptional facts” are worth exploring.

The debtors provided laboratory-based diagnostic services that derived significant revenue from Medicare and Medicaid reimbursements. The creditor appellants were lenders of about $106.3 million of senior secured debt to the debtors under a $1.825 billion credit facility, which was part of a “dividend recapitalization” transaction for the benefit of certain non-debtor shareholders of the debtor holding company. Less than a year after the credit facility closed and following an investigation that lasted several years, the Department of Justice (DOJ) filed, and ultimately settled with the debtors, a complaint against them alleging violations of various laws, including the False Claims Act. Compounding the DOJ claims, the Centers for Medicare and Medicaid Services (CMS) also threatened to revoke the “lifeblood” of the debtors’ business—Medicare billing privileges. The government entities required, inter alia, the debtors to make a $256 million settlement payment to the government before a date certain to avoid revocation of their billing privileges. See id. at *1–2. To avoid a default under the settlement with the DOJ and the CMS, the parties entered into a hotly negotiated restructuring agreement whereby (a) the non-debtors agreed to pay $325 million to be used to pay the outstanding settlement amount due to the government entities and cover certain of the debtors’ fees, costs, and working capital requirements; (b) the non-debtors agreed to transfer 100 percent of their equity interests in the debtors to the lenders; and (c) the non-debtors would receive full releases for themselves regarding all claims arising from conduct that occurred before the restructuring agreement. The Millennium Lab court emphasized that the release provisions the non-debtors obtained in exchange for their contribution, were, in short, “heavily negotiated among the Debtors, the Equity Holders and the Ad Hoc Group” and necessary to the entire agreed resolution. Id. at *3. Also, the non-debtors’ contribution was also necessary to induce the lenders’ support of the restructuring agreement. “Thus, as stated by both the Bankruptcy Court and District Court after careful fact finding, the deal to avoid corporate destruction would not have been possible without the third-party releases.” Id. During these negotiations, a group of the lenders suggested that they had potential claims against the non-debtors stemming from the credit facility, which suggestion was denied by the non-debtors.

After the appellant lenders “held out” of an out-of-court reorganization process involving a substantial majority of the debtors’ pre-petition lenders, the debtors filed for bankruptcy in November of 2015. The pre-petition restructuring agreement and related agreements formed the “centerpiece” of the plan of reorganization that the debtors filed on November 10, 2015, which provided broad releases, including ones that would bind non-consenting lenders such as the appellant lenders in favor of the debtors and non-debtor equity holders, among others. The plan releases specifically covered any claims “arising out of, or in any way related to in any manner,” the credit facility. To enforce the releases, the plan also provided for a bar order and an injunction prohibiting those bound by the releases from commencing or prosecuting any actions with respect to the claims released under the plan. Id.

The bankruptcy court confirmed the plan over the objection of the appellant lenders, and, on appeal, the district court remanded, requiring the bankruptcy court to consider whether the bankruptcy court had constitutional authority to confirm a plan releasing the appellants’ claims in light of the Supreme Court’s decision in Stern v. Marshall, 564 U.S. 462 (2011). On remand, the bankruptcy court concluded that it did have constitutional authority, that Stern did not apply to plan confirmation proceedings, and that the requirements of Stern were met even if Stern did apply. The district court affirmed the bankruptcy court’s conclusion that Stern did not apply and dismissed the remaining issues as equitably moot.

The appeal ensued.

The National Legal Framework Concerning Nonconsensual Third-Party Releases

The Third Circuit’s Millennium Lab decision does not exist in a vacuum; rather, circuit courts were, and remain, split as to whether a bankruptcy court has the authority to issue a non-debtor release and enjoin a non-consenting party from making claims against the non-debtor. See In re Seaside Eng’g & Surveying, Inc., 780 F.3d 1070, 1077 (11th Cir. 2015). Predictably, the split featured a “majority” and “minority” view.

The “minority view” adopted by the Fifth, Ninth, and Tenth Circuits provides that bankruptcy courts lack the power to grant nonconsensual third-party releases. See, e.g., Bank of N.Y. Tr. Co. v. Official Unsecured Creditors’ Comm. (In re Pac. Lumber Co.), 584 F.3d 229, 251–53 (5th Cir. 2009); Resorts Int’l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1401–2, 1402 n.6 (9th Cir. 1995); Matter of Zale Corp., 62 F.3d 746, 760 (5th Cir. 1995); Landsing Diversified Props.-II v. First Nat’l Bank & Tr. Co. of Tulsa (In re W. Real Estate Fund, Inc.), 922 F.2d 592, 600–602 (10th Cir. 1990), modified sub nom. Abel v. West, 932 F.2d 898 (10th Cir. 1991). These courts base their conclusion on section 524(e) of the Bankruptcy Code, which provides in relevant part: “[D]ischarge 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” (e.g., 11 U.S.C. § 524(e)). These courts hold that the bankruptcy court has no power to discharge the liabilities of a non-debtor as part of a reorganization plan because section 524(e) “precludes discharging the liabilities of non-debtors.” See e.g., Lowenschuss, 67 F.3d at 1402. Accordingly, under the minority view, release and permanent injunctions are seen to be indistinguishable from a bankruptcy discharge under section 524. See, e.g., Landsing Diversified, 922 F.2d at 601; Am. Hardwoods, Inc. v. Deutsche Credit Corp., 885 F.2d 621, 626 (9th Cir. 1989). Accord In re Pac. Lumber Co., 584 F.3d at 252 (“In a variety of contexts, this court has held that Section 524(e) only releases the debtor, not co-liable third parties.”).

The “majority view” adopted by the Second, Fourth, Sixth, and Eleventh Circuits is not as strict. Those courts have held that bankruptcy courts have the power to impose involuntary releases, but that such involuntary releases should be imposed “only in rare cases.” Seaside Eng’g, 780 F.3d at 1078; Nat’l Heritage Found., Inc. v. Highbourne Found., 760 F.3d 344, 347–50 (4th Cir. 2014); Behrmann v. Nat’l Heritage Found., 663 F.3d 704, 712 (4th Cir. 2011); In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141–43 (2d Cir. 2005); *723 Class Five Nev. Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F.3d 648, 657–58 (6th Cir. 2002); Menard-Sanford v. Mabey (In re A.H. Robins Co., Inc.), 880 F.2d 694, 700–702 (4th Cir. 1989). Prior to the Millennium Lab decision, the Third Circuit also appeared to allow for such releases as well. In In re Continental Airlines, 203 F.3d 203 (3d Cir. 2000), the court canvassed the law as it had been developed at the time and expressly declined to “establish [its] own rule regarding the conditions under which non-debtor releases and permanent injunctions are appropriate or permissible,” because the proposed releases in the debtors’ plan for certain non-debtor director and officer defendants “[did] not pass muster under even the most flexible tests for the validity of non-debtor releases.”

What is clear, however, is that nonconsensual third-party releases, even under the “majority” view, are subject to “considerable scrutiny” and they are permitted “only if they meet certain conditions.” In re Kirwan Offices S.a.r.l., 592 B.R. 489, 503 (S.D.N.Y. 2018). Further, as the U.S. District Court for the Southern District of New York recently noted in Kirwin Offices, the developed law from which the Millennium Lab decision emanated was not definitive as to the jurisdictional underpinnings of the “majority” view:

There is no consensus among courts holding the majority view as to which jurisdictional basis is implicated when a bankruptcy court considers involuntary third-party releases. Some authorities posit that the only jurisdictional basis for a bankruptcy court to extinguish third-party claims permanently is through an exercise of non-core jurisdiction. Others submit that, when involuntary third-party releases are considered in connection with confirmation proceedings, bankruptcy courts act pursuant to their core jurisdiction.  

Under this latter approach, a bankruptcy court acts pursuant to its core jurisdiction when it considers the involuntary release of claims against a third-party non-debtor in connection with the confirmation of a proposed plan of reorganization, which is a statutorily defined core proceeding.

A Note about Bankruptcy Jurisdiction and Stern

A word or two about the Stern decision and the principles of jurisdiction undergirding it is appropriate because it plays an important role in understanding the Millennium Lab holding.

In Stern, the Supreme Court broadly held that a bankruptcy court had gone beyond its jurisdictional constitutional limits when it resolved and entered final judgment on a state common-law claim that should have, in the Court’s view, been resolved by an Article III court. Bankruptcy courts have original jurisdiction over all bankruptcy cases and related proceedings. See 28 U.S.C. § 1334(a)–(b). The authority of bankruptcy courts, however, depends on whether the matter qualifies as a so-called “core” proceeding—i.e., one that “aris[es] in” or “under” Title 11—or a so-called “[n]on-core proceedin[g]” or “Stern claim”—i.e., one that is only “related to” a bankruptcy case.

In Wellness International Network, Ltd. v. Sharif, 135 S. Ct. 1932, 1940 (2015), the bankruptcy court ruled that “Congress identified as ‘[c]ore’ a nonexclusive list of 16 types of proceedings in which it thought bankruptcy courts could constitutionally enter judgment.” If it is a core proceeding, a bankruptcy court may “hear and determine” the case and “enter appropriate orders and judgments,” subject to appellate review by the district court. If it is a proceeding involving non-core or Stern claims, the bankruptcy court’s authority is limited—it may “hear and determine” such proceedings, and “enter appropriate orders and judgments,” but only “with the consent of all the parties to the proceeding.” “Absent consent, bankruptcy courts in non-core proceedings may only ‘submit proposed findings of fact and conclusions of law,’ which the district courts review de novo.”  

The Millennium Lab court took away three important points from Stern and its progeny: (1) Bankruptcy courts may violate Article III even while acting within their statutory authority in “core” matters and, therefore, it may be necessary to consider whether that exercise of authority comports with the Constitution even when the court exercises its core authority; (2) a bankruptcy court is within constitutional bounds when it resolves a matter that is integral to the restructuring of the debtor-creditor relationship; and (3) when determining whether a bankruptcy court has acted within its constitutional authority, courts should generally focus not on the category of the “core” proceeding but rather on the content of the proceeding (and how connected the underlying proceeding was to the bankruptcy case).

The Third Circuit Breathes New Life into Nonconsensual Third-Party Releases

After walking through the “exceptional” facts, and operating within the broad parameters of the above-referenced national framework, the Third Circuit squarely addressed whether a bankruptcy court can confirm a Chapter 11 plan containing nonconsensual third-party releases and injunctions without violating Article III of the Constitution. The Millennium Lab court held that the bankruptcy court possessed constitutional authority to confirm the plan containing the release provisions. Indeed, the bankruptcy court “indisputably had ‘core’ statutory authority to confirm the plan” in confirming the debtors’ Chapter 11 plan and, therefore, the court cabined its inquiry to resolving “whether, looking to the content of the plan, the Bankruptcy Court was resolving a matter integral to the restructuring of the debtor-creditor relationship.” The Millennium Lab court ruled that it was because the bankruptcy court determined that the challenged release and injunction provisions of the confirmed plan were critical to the success of the plan and critical to securing the non-debtors’ substantial contribution.

To reach this holding, the Millennium Lab court resolved two principal arguments raised by the appellant lenders. First, the court rejected the appellants’ argument that “Stern demands an Article III adjudicator decide its RICO/fraud claims [valued at $70 million] because those claims do not stem from the bankruptcy itself and would not be resolved in the claims-allowance process.” To the court, this argument failed to faithful apply Stern, which extended beyond that claim allowance process to matters integral to the debtor-creditor relationship. Second, the appellant lenders argued that the power of bankruptcy courts would “be essentially limitless and that an ‘integral to the restructuring’ rule would mean that bankruptcy courts could approve releases simply because reorganization financers demand them, which could lead to gamesmanship.” This argument, too, failed because the court was emphatically not “broadly sanctioning the permissibility of nonconsensual third-party releases in bankruptcy reorganization plans.” Rather, the Millennium Lab court emphasized that nonconsensual third-party releases and injunctions in the bankruptcy plan context must satisfy exacting standards “if such releases and injunctions are to be permitted”; “courts considering such releases do so with caution” consistent with precedent mandating that such releases be fair, necessary to the reorganization, and supported by specific factual conclusions.

Takeaways for Litigators and Bankruptcy Professionals Alike

Nonconsensual releases of creditor claims against non-debtors have always been a controversial issue, particularly where, as in Millennium Lab, valuable pre-petition claims against non-debtors are effectively eliminated. But, for counsel representing a debtor-in-possession, trial attorneys with a creditor client holding a significant claim against a debtor-in-possession, or in-house counsel to a bank or lending institution, Millennium Lab provides several takeaways that are worth highlighting.

  • Although the Millennium Lab court did specifically hold that the bankruptcy court possessed the constitutional authority under Stern and article III to confirm a plan containing nonconsensual releases of claims against non-debtors, the court, at the same time, emphasized that the “exacting standards” developed by prior courts must be satisfied if such releases and injunctions are to be permitted, and strongly suggested that courts considering such releases do so with caution. Thus, the bankruptcy process should not be, on a normative level, a haven for the broad use of nonconsensual third-party releases.
  • The Millennium Lab court’s holding was limited and specific to the particular facts of the case, and those facts provided some insight into what at least one non-debtor had to put into the reorganization to obtain the challenged third-party releases. Specifically, the non-debtors in Millennium Lab contributed $325 million in exchange for the releases they ultimately obtained. This sum was heavily negotiated during what the court described as a “highly adversarial” and complex process.
  • The court clarified what has been, and remains, a minefield of jurisdictional jurisprudence since the Stern decision was rendered. Particularly, the Millennium Lab court contextualizes important teachings from Stern and its progeny: that the exercise of “core” statutory authority by a bankruptcy court can implicate the limits imposed by Article III; that such an exercise of authority is permissible if it involves a matter integral to the restructuring of the debtor-creditor relationship; and that, in determining whether a bankruptcy court’s exercise of authority implicates such an “integral” matter, the court will consider the content of the “core” proceeding at issue.

In jurisdictions that have permitted nonconsensual third-party releases, Millennium Lab should not displace the fundamental function that the bankruptcy court plays in ensuring that the releases are fair, necessary for reorganization, and supported by evidence. Thus, the court must still conduct an exacting review of the specific claims that debtors believe must be barred in order to enable the reorganization, the contributions made by the proposed releasees, whether the releasing parties are otherwise getting recoveries on those released claims, and the fairness of the releases from the point of view of the people on whom the releases are to be imposed.