The economic fallout from the COVID-19 pandemic will leave in its wake a significant increase in commercial chapter 11 filings. Many of these cases will feature extensive litigation involving breach of contract claims, business interruption insurance disputes, and common law causes of action based on novel interpretations of long-standing legal doctrines such as force majeure. These issues could be particularly problematic to resolve because of questions stemming from recent Supreme Court decisions regarding the constitutional authority of United States bankruptcy courts to make final rulings on these types of disputes. Fortunately, however, a recent decision by the U.S. Court of Appeals for the Third Circuit in the case of Millennium Lab Holdings suggests a different approach for addressing these constitutional concerns. The Third Circuit’s approach anticipates where the Supreme Court’s jurisprudence appears to be heading, and should provide useful guidance to bankruptcy courts during what is going to be a challenging period for both judges and practitioners.

Uncertainties regarding the authority of bankruptcy courts to issue final orders in certain types of cases have existed for decades, but were mostly quiescent until the Court’s opinion nine years ago in Stern v. Marshall.  In that case, which arose out of the endless litigation between Anna Nicole Smith and the son of her late husband, the Supreme Court stunned the commercial legal community by reopening what many had believed were long-settled constitutional questions regarding the United States bankruptcy courts.  Since then, practitioners and lower courts have struggled to deal with the ramifications of that decision.

The problems created by Stern, in a nutshell, are as follows:

Congress has the express power under Article I, Section 8 to pass uniform laws on bankruptcy. It used that power to create the modern bankruptcy court system pursuant to Article I of the Constitution rather than under Article III, the source of the federal government’s judicial power.

However, the Supreme Court has long held that “separation of powers” concerns require that Article I courts be limited to territorial courts, military tribunals, and courts created to hear cases involving “public rights” (e.g., 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.

Prior to Stern, it was generally believed that matters pertaining (in the Court’s words) to “the restructuring of debtor-creditor relations, which is at the core of federal bankruptcy power” under Article I, constituted a type of “public right” that could be heard and decided by an Article I bankruptcy judge.

The Court, however, never handed down a clear ruling as to where the line between “public rights” and “private rights” should be drawn in bankruptcy proceedings, even though “the restructuring of debtor-creditor relations” often necessitates the resolution of “private rights” disputes. Moreover, the Court, both in Stern and in recent non-bankruptcy cases, has significantly narrowed the “public rights” doctrine.

This has created confusion and given rise to substantial litigation in bankruptcy cases over the constitutional authority of bankruptcy judges to issue final orders on numerous issues which could implicate “private rights.”

In Millennium, the Third Circuit affirmed lower court opinions that turned aside a constitutional challenge to the authority of a bankruptcy court to confirm a plan of reorganization. The plan included the non-consensual release by third parties of certain claims against various non-debtor entities. 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 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 had commenced separate litigation against the equity holders, and objected to the releases in the plan that would preclude their claims. The lenders contended that under Stern the releases were tantamount to resolving a “private rights” dispute between two non-debtor parties, and that the bankruptcy court therefore lacked constitutional authority to enter a final order resolving it.

The Third Circuit rejected the lenders’ arguments. However, the decision avoids the thicket of the Supreme Court’s “public rights” jurisprudence, and strongly implies that such jurisprudence no longer provides support for bankruptcy courts’ constitutional authority to issue final orders which are dispositive of parties’ “private rights.” The Third Circuit reviews the Court’s recent decisions in this area and suggests that the Court is heading towards an alternative approach:

Judge Kent A. Jordan, writing for the court, steps away from the “public rights” doctrine and towards a straight-forward alternative – an express recognition that specialized bankruptcy courts under Article I should be viewed as an additional category of historical exception to the judicial power of Article III.

This would place the constitutional authority of bankruptcy courts to make dispositive rulings in cases involving “private rights” on far firmer ground than it currently rests under the “public rights” doctrine. Judge Jordan cites a passage that appears to endorse the “historical exception” rationale from a recent separate opinion by Chief Justice Roberts, who authored Stern:

“When the Framers gathered to draft the Constitution, English statutes had long empowered nonjudicial bankruptcy ‘commissioners’ to collect a debtor’s property, resolve claims by creditors, order the distribution of assets in the estate, and ultimately discharge the debts. This historical practice, combined with Congress’s constitutional authority to enact bankruptcy laws, confirms that Congress may assign to non-Article III courts adjudications involving ‘the restructuring of debtor-creditor relations, which is at the core of the federal bankruptcy power.’”

This approach has also been suggested in a separate opinion by Justice Thomas, who was part of the Court’s majority in Stern:

“Congress . . . has assigned the adjudication of certain bankruptcy disputes to non-Article III actors since as early as 1800. . . Bankruptcy courts clearly do not qualify as territorial courts or courts-martial, but they are not an easy fit in the “public rights” category, either. . . We have nevertheless implicitly recognized that the claims allowance process may proceed in a bankruptcy court, as can any matter that would necessarily be resolved by that process, even one that affects core private rights. . . . For this reason, bankruptcy courts . . . more likely enjoy a unique, textually based exception, much like territorial courts and courts-martial do. . .  That is, Article I’s Bankruptcy Clause serves to carve cases and controversies traditionally subject to resolution by bankruptcy commissioners out of Article III, giving Congress the discretion, within those historical boundaries, to provide for their resolution outside of Article III courts.”

The Supreme Court has attempted for many years to force bankruptcy courts to fit within the permissible parameters for courts created under Article I – territorial courts, military tribunals, and courts created to hear cases involving public rights – but that effort appears to have run its course and has led to uncertainty and confusion. Judge Jordan’s opinion indicates that the Third Circuit believes that the Supreme Court is in the process of abandoning its efforts to apply “public rights” jurisprudence to the specialized system of bankruptcy courts created by Congress, and is on course instead to recognize such courts as a fourth category of exception to Article III courts.

Millennium is now binding precedent in the Third Circuit. It will likely be interpreted broadly by the judges in the District of Delaware, one of the most influential bankruptcy districts in the country, and be viewed as persuasive authority by judges elsewhere. With a plethora of “private rights” litigation in bankruptcy cases on the immediate horizon, the reasoning of Millennium, if ultimately adopted by the Supreme Court, will place bankruptcy courts’ ability to make final rulings in such matters on firmer constitutional footing, and end much of the uncertainty and needless litigation over bankruptcy judges’ authority.