In December 2015, U.S. Bankruptcy Court Judge Laurie Silverstein of the District of Delaware confirmed a plan of reorganization in the Millennium Lab Holdings chapter 11 case that included the non-consensual release of certain claims against various non-debtor third parties. Earlier this year, ruling on an appeal from that decision, U.S. District Court Judge Leonard Stark remanded the case to Judge Silverstein and directed her to consider whether the grant of the releases exceeded her constitutional power as an Article I judge, in view of the issues raised by the U.S. Supreme Court in its 2011 decision in Stern v. Marshall.
Judge Silverstein recently issued a comprehensive opinion in which she determined that her confirmation of the plan was constitutional and did not contravene Stern. Her analysis brings much-needed clarity to what has been a muddled discussion. Her unstated premise – that a viable specialized court system is necessary to address matters of bankruptcy, and that Congress unquestionably has the power under Article I to create such forums – offers a pathway out of the uncertainty created by Stern over the constitutional power of the U.S. bankruptcy courts.
The Supreme Court in Stern raised long dormant separation of power concerns. Under the U.S. Constitution, the “judicial power” of the United States can only be exercised by courts created under Article III. Congress, however, established the U.S. bankruptcy courts in their current form in 1978 pursuant to its bankruptcy power under Article I. A line of Supreme Court cases has limited the authority of courts created by Congress pursuant to Article I, rather than under Article III, to territorial courts, military tribunals, and courts created to hear cases involving “public rights” (i.e., cases involving claims of citizens against the government). Claims of citizens against one another under state law, such as for breach of contract or common torts, are “private rights” that must be heard by an Article III judge.
The Court, in the 1982 Northern Pipeline case, invalidated the 1978 grant of jurisdiction to the bankruptcy courts, ruling that Congress had impermissibly vested Article III “judicial power” in Article I courts by allowing a bankruptcy court to hear and rule on a debtor’s breach of contract claim against another party, a “private rights” dispute. It did, however, provide some guidance to Congress by suggesting that disputes pertaining to “the restructuring of debtor-creditor relations, which is at the core of federal bankruptcy power,” (emphasis added) constituted a type of “public right” which could be heard and decided by an Article I bankruptcy judge. Congress responded with a new grant of jurisdictional power providing that bankruptcy courts could issue final orders with respect to a variety of enumerated “core” matters intended to implicate only such “public rights,” but that with respect to “non-core” matters affecting “private rights,” a bankruptcy court could only submit proposed findings of fact and conclusions of law, and requiring that a final order on such matters be entered by an Article III district court following a full review.
The constitutionality of the “core” – “non-core” dichotomy appeared to have been long-settled by 2011, as in cases involving other Article I tribunals the Court took an expansive view of the “public rights” doctrine, one that had appeared to be sufficiently broad to encompass the list of “core” bankruptcy matters. So it took most bankruptcy practitioners and commentators by surprise when, in Stern, the Court held that Congress had again improperly granted authority to bankruptcy courts to make certain final rulings. Stern ruled that Congress could not designate a debtor’s counterclaim against a creditor as a “core” matter if the counterclaim would not be resolved as part of the same process whereby the creditor’s claim against the debtor’s bankruptcy estate was determined. The Court in Stern ruled that it would be unconstitutional for the counterclaim in that case, a tort action under Texas state law, to be decided by an Article I bankruptcy judge. In the Court’s view, if the matter would exist under state law “without regard to any bankruptcy proceeding,” then it is a “private right” upon which an Article I bankruptcy judge cannot make a final ruling.
The problem with this reasoning is that the Supreme Court has expressly stated in other cases that parties’ rights in bankruptcy are usually determined by state law. State law issues accordingly are intertwined with most “core” matters. Although the Court in Stern characterized its ruling as “narrow,” its formulation of the issue suggested that “core” matters could often implicate “private rights.” By opening up issues of bankruptcy court power regarding “core” matters to constitutional challenge, the Court created ongoing confusion regarding the extent to which U.S. bankruptcy judges can issue final rulings, which in turn has caused uncertainty in the administration of bankruptcy cases.
Millennium Lab Holdings Chapter 11 Case
In Millennium Lab Holdings, the debtor’s equity holders had been accused of orchestrating fraudulent activity in connection with the debtor’s Medicare and Medicaid reimbursement requests. The plan confirmed by Judge Silverstein in 2015 embodied a compromise, whereby the equity holders were to pay $325 million in exchange for a release of all claims against them held either by the debtor’s estate or directly by third parties. Certain of the debtor’s lenders commenced litigation against the equity holders in federal district court, and objected to the releases in the plan that would preclude their claims. Judge Silverstein overruled the objections. She held that the non-consensual releases met the required standards under Third Circuit precedents and could be approved in connection with the confirmation of a plan of reorganization.
The constitutional issues were raised for the first time on appeal. The lenders contended that under Stern the releases were tantamount to resolving a “private rights” dispute between two non-debtor parties, and that Judge Silverstein therefore lacked constitutional authority to enter a final order resolving it. Judge Stark agreed that the lenders were entitled to Article III adjudication of their claims, but determined that the issue had not been properly presented to Judge Silverstein, and remanded the case so that she could make the determination in the first instance.
Judge Silverstein’s Ruling on Remand
In her ruling, Judge Silverstein noted first the Supreme Court’s own admonition in Stern that it was intended to be a narrow opinion, and that its actual outcome “tread little new ground” beyond Northern Pipeline. She then looked closely at the interpretations applied to Stern by various courts since its issuance. Some bankruptcy judges have applied what she characterized as a “Narrow Interpretation,” limiting Stern to similar circumstances involving state law counterclaims against creditors that are not resolvable in the process of ruling on the creditor’s claims against the debtor. Other bankruptcy judges have put forward a “Broad Interpretation” of Stern, holding that it may apply to any state law or common law cause of action commenced by a debtor or trustee against a creditor or other party. Under what she describes as the “Broadest Interpretation,” bankruptcy judges have questioned their ability to enter final orders in other enumerated “core” proceedings.
The lenders argued that Stern did not permit Judge Silverstein to enter a final order confirming a plan of reorganization that would interfere with their causes of action against the debtor’s equity holders. She rejected the lenders’ argument as “inverse” and “backward” reasoning: “[I]t examines the legal consequence of the confirmation order to find fault with the entry of the order, rather than examining the propriety of issuing the confirmation order in the first instance.” She determined instead that an Article I judge should not step aside from issuing a ruling on a “core” matter simply because third parties’ rights under state or common law would be affected.
Judge Silverstein demonstrated that even under the “Broadest Interpretation” of Stern, her entry of a final order confirming the plan was within her authority. She approached the constitutional question by noting that confirming plans of reorganization are a fundamental aspect of federal bankruptcy power, and placing the critical focus squarely on the nature of the “core” proceeding that was before her. Although the plan affected the “private rights” of third parties by releasing certain causes of action, she held that she was not ruling on the merits of those causes of action. Her decision was only on whether the plan (and the releases) satisfied applicable standards under the Bankruptcy Code and Third Circuit precedent:
“[T]here is no state law equivalent to confirmation of a plan. And, third party releases do not exist without regard to the bankruptcy proceeding. Rather, a ruling approving third party releases is a determination that the plan at issue meets the federally created requisites for confirmation and third party releases.”
Adopting the interpretation of Stern urged by the lenders, she observed, would effectively end the viability of the U.S. bankruptcy court system, and require substantially greater involvement by Article III district court judges in bankruptcy matters – an outcome directly at odds with the Supreme Court’s stated intention in Stern that its ruling would not “meaningfully change the division of labor” between bankruptcy and district courts. She noted several types of orders commonly entered by bankruptcy judges which, under the lenders’ reading of Stern, would instead need to be entered by Article III judges due to their possible impact on the rights of non-debtors under state law. These would include orders approving sales of assets free and clear of successor liability claims under Section 363 of the Bankruptcy Code, rulings on substantive consolidation, and determinations regarding the recharacterization or subordination of debts.
Judge Silverstein tangentially alluded to the real problem raised by Stern – that by failing to articulate clearly the importance of federal bankruptcy law and a specialized bankruptcy court system as “public rights,” the Court allowed Stern to become fodder for “gamesmanship by both debtors and creditors in the bankruptcy context.” Citing a recent Third Circuit ruling, In re Linear Electric Company, Inc., she expressly held “core” matters under the Bankruptcy Code to be “public rights.” As such, it fell directly within her power as an Article I bankruptcy judge to confirm the Millennium Lab Holdings plan. In Judge Silverstein’s view, “[t]here is no question [that] if the proper standard is met, a bankruptcy judge may enter a final order in a core matter that impacts or even precludes a state law action between two non-debtors.” The preclusive effect of a ruling on the “private rights” of a non-debtor party might be an argument for a bankruptcy court to consider in weighing the merits of the releases themselves, but it could not limit the constitutional authority of a U.S. bankruptcy judge to make such a ruling.
In articulating the limits of Stern under any of its plausible interpretations, Judge Silverstein has provided guidance that can and should be followed by other courts towards viewing “core” matters as “public rights” squarely within the constitutional authority of an Article I court. The key factor in resolving questions of bankruptcy court constitutional authority should be the nexus of any particular dispute to “the restructuring of debtor-creditor relations,” instead of whether parties’ rights under state law are affected. Placing the focus on the “public” side of the public/private rights dichotomy can provide a path away from the confusion engendered by Stern, and restore the proper balance of U.S. bankruptcy courts’ constitutional power.