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In re Millennium Lab Holdings II, LLC

United States District Court, D. Delaware

March 17, 2017




         Millennium Lab Holdings II, LLC, and its affiliated reorganized debtors (collectively, the "Debtors"), move this Court (D.I. 6) (the "Motion to Dismiss")[2] to dismiss the appeal filed by ISL Loan Trust and certain affiliated funds (collectively, "Appellants") from an order (B.D.I. 195)[3] ("Confirmation Order") entered by the United States Bankruptcy Court for the District of Delaware ("Bankruptcy Court") confirming the Debtors' Amended Prepackaged Joint Chapter 11 Plan of Reorganization (B.D.I. 182) (as amended, the "Plan"), on the basis that the appeal is equitably moot. For the reasons stated below, the Court will deny the Motion to Dismiss without prejudice and remand to the Bankruptcy Court for further proceedings.


         The appeal of the Confirmation Order concerns a matter of some controversy: the approval of nonconsensual third-party releases (i.e., the involuntary extinguishment of a non-debtor, third-party's claim against another non-debtor, third party) as part of a chapter 11 plan of reorganization. Here, the Plan released a non-debtor, third-party's direct, non-bankruptcy, common law fraud and RICO claims against non-debtor equity holders. The issues on appeal include, inter alia, (1) whether the Bankruptcy Court had subject matter jurisdiction to approve the nonconsensual third-party releases, and (2) whether the Bankruptcy Court had constitutional authority to permanently release the claims post-Stern.[4]

         A. Adjudicatory Authority and Subject Matter Jurisdiction

         Article III imposes a structural limitation on the power of an Article I court to enter final orders or judgments on state law claims without the parties' consent. As the Supreme Court explained in Wellness Int'l Network, Ltd. v. Sharif:

Article III, § 1, of the Constitution provides that "[t]he judicial Power of the United States, shall be vested in one supreme Court, and in such inferior Courts as the Congress may from time to time ordain and establish." Congress has in turn established 94 District Courts and 13 Courts of Appeals, composed of judges who enjoy the protections of Article III: life tenure and pay that cannot be diminished. Because these protections help to ensure the integrity and independence of the Judiciary, "we have long recognized that, in general, Congress may not withdraw from" the Article III courts "any matter which, from its nature, is the subject of a suit at the common law . . . ."
Congress has also authorized the appointment of bankruptcy and magistrate judges, who do not enjoy the protections of Article III, to assist Article III courts in their work .... Congress' efforts to align the responsibilities of non-Article III judges with the boundaries set by the Constitution have not always been successful.... [R]ecently in Stern, this Court held that Congress violated Article III by authorizing bankruptcy judges to decide certain claims for which litigants are constitutionally entitled to an Article III adjudication.

135 S.Ct. 1932, 1938-39 (2015) (internal citations omitted). It is clear from these recent Supreme Court cases that parties have a constitutional right to have their common law claims adjudicated by an Article III court, and that right cannot be abridged by Congressional action.

         Federal bankruptcy jurisdiction is a Congressional creation under 28 U.S.C. § 1334(b), which provides that "district courts shall have original and exclusive jurisdiction of all cases under title 11, " and original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11." The authority of Bankruptcy Courts to oversee bankruptcy matters derives from 28 U.S.C. § 157(a), which sets out that "[e]ach district court may provide for any or all cases under title 11 and any or all proceedings arising under title 11 or arising in or related to a case under title 11 shall be referred to the bankruptcy judges for the district."

         Despite the District Court's general referral of bankruptcy matters to the Bankruptcy Court, the extent of the Bankruptcy Court's adjudicatory authority depends on the type of proceeding before it and is subject to the bounds of the constitutional limitations described above. Thus, Bankruptcy Courts may "enter appropriate orders and judgments" only in "cases under title 11" and "core proceedings arising under title 11, or arising in a case under title 11." 28 U.S.C. § 157(b)(1). When a matter is not a "core" proceeding but rather is "related to" a bankruptcy case, Bankruptcy Courts have authority only to "hear" the matter and submit proposed findings of fact and conclusions of law to the Article III District Court. 28 U.S.C. § 157(c)(1).[5] This limitation on the power of Article I judges to enter final orders in non-core proceedings protects a party's constitutional right to have its common law claims adjudicated by an Article III court. An exception to this limitation applies where all of the parties to the proceeding consent to the Bankruptcy Court's entry of final orders. See 28 U.S.C. § 157(c)(2); Wellness, 135 S.Ct. at 1942 (holding that Article III permits consent-based adjudication by Bankruptcy Court).

         B. Subject Matter Jurisdiction Over Nonconsensual Third-Party Releases

         The permanent release of a non-debtor, third-party's claim against another non-debtor, third party - whether through a chapter 11 plan or otherwise - is an exercise of the Bankruptcy Court's "related to" jurisdiction. See In re Combustion Eng'g, Inc., 391 F.3d 190, 224, 233 (3d Cir. 2005) (holding that chapter 11 plan could not permanently enjoin third-party claims because "related to" jurisdiction did not exist over such claims); In re Congoleum Corp., 362 B.R. 167, 190-91 (Bankr. D.N.J. 2007) (stating that "first hurdle" to approval of release is establishing that court had related to jurisdiction). This is because a non-debtor's pre-bankruptcy claim against another non-debtor does not "aris[e] under title 11" and does not "aris[e] in a case under title 11." 28 U.S.C. § 157(b)(1); see also In re Digital Impact, Inc., 223 B.R. 1, 11 (Bankr. N.D. Okla. 1998) (holding that controversies are not "cases under" title 11 where parties thereto are not debtors in bankruptcy, and that controversies did not "arise under" Code, because "controversies contemplated [between the parties] are not limited to causes of action under the Bankruptcy Code, such as avoidance actions"). Thus, a proceeding solely between non-debtor parties based on non-bankruptcy law can only be heard by Bankruptcy Courts under "related to" jurisdiction, and then only "if the outcome could alter the debtor's rights, liabilities, options, or freedom of action (either positively or negatively) and which in any way impacts upon the handling and administration of the bankrupt estate." Pacor, Inc. v. Higgins, 743 F.2d 984, 994 (3d Cir. 1984); see also Celotex Corp. v. Edwards, 514 U.S. 300, 307 n.5 (1995) ("Proceedings 'related to' the bankruptcy include . . . suits between third parties which have an effect on the bankruptcy estate."). As such, whether a Bankruptcy Court has "related to" subject matter jurisdiction over the nonconsensual release of third-party claims is frequently litigated. Once established, a common plan objection is based on the statutory edict that a Bankruptcy Court exercising "related to" jurisdiction over non-core proceedings cannot issue final orders or judgments but is instead limited to issuing proposed findings of fact and conclusions of law. See 28 U.S.C. § 157(c)(1).

         Conversely, plan proponents frequently argue that because Congress included "confirmations of plans" in its list of "core proceedings" under the statute, the nonconsensual release of third-party claims is an exercise of the Bankruptcy Court's "arising in" or "arising under" jurisdiction when accomplished in the context of the plan, and therefore the Bankruptcy Court has authority to enter a final order releasing those claims. See 28 U.S.C. § 157(b)(2). The weakness of this argument is its treatment of a chapter 11 plan as a jurisdictional and adjudicatory "blank check." Indeed, courts have repeatedly rejected this type of jurisdictional and adjudicatory bootstrapping.[6]

         C. Adjudicatory Authority Yost-Stern

         In Stern, the Supreme Court held it unconstitutional for Congress to give Bankruptcy Courts - which are not established under Article III of the Constitution - final adjudicatory authority over a bankruptcy estate's defamation counterclaim against an estate creditor, notwithstanding that such counterclaims are among the proceedings that Congress has listed as "core." See 131 U.S. at 2600-01 (concluding that although Bankruptcy Court had statutory authority to enter final judgment on certain counterclaims pursuant to 28 U.S.C. § 157(b)(2)(C), it lacked constitutional authority to render final judgment). According to the Supreme Court, the counterclaim at issue did not fall within the narrow "public rights" exception to Article III requirements;[7] rather, the claim arose under state law between private parties and was, therefore, a matter of "private right, that is, of the liability of one individual to another." Id. at 2611-12, 2614 (internal quotations omitted). That the defendant filed a proof of claim in the bankruptcy case did not alter this conclusion because: (i) the counterclaim did not arise from the bankruptcy itself; and (ii) it was not necessary to resolve the counterclaim as part of the process of allowing or disallowing the creditor's proof of claim. See Id. at 2611. Stern made clear the limitation on a Bankruptcy Court's authority to enter a final order on a non-core claim for which the claimant has a constitutional right to adjudication by an Article III court. The Supreme Court later clarified that parties could consent to final adjudication by a non-Article III court. See Wellness, 135 S.Ct. at 1944-45.

         Following Stern, it is clear that regardless of whether the Bankruptcy Court has subject matter jurisdiction over proceedings - both core and non-core - it cannot enter a final order releasing third-party claims unless it has constitutional authority to do so as well.


         A. Events Leading to Chapter 11 Filing

         Appellants[8] were lenders of approximately $106.3 million of aggregate principal amount of senior secured debt issued in April 2014 pursuant to a $1, 825 billion senior secured credit facility (the "Credit Facility") which was governed by a credit agreement dated April 16, 2014 (the "Credit Agreement") among, inter alia, Debtors Millennium Lab Holdings II, LLC ("Holdings") and Millennium Health, LLC, f/k/a Millennium Laboratories, LLC ("Millennium"), and several other lenders (the "Lenders"). (See D.I. 14 at ¶ 108, Al 128) The Credit Facility was issued as part of a "dividend recapitalization" transaction for the benefit of what would then be the non-debtor stockholders of Millennium's parent company, Holdings. (D.I. 14 At A108) The stock of Holdings was owned approximately 55% by non-debtor Millennium Lab Holdings, Inc. ("MLH"), [9] and approximately 45% by non-debtor TA Millennium, Inc. ("TA")[10] (MLH and TA, collectively, the "Non-Debtor Equity Holders"). (Id.) Of the $1.775 billion of term loan proceeds under the Credit Facility, nearly $1.3 billion was paid out as a special dividend to the Non-Debtor Equity Holders. (B.D.I. 206, 12/11/15 Hr'g. Tr. at 8:9-8:13; D.I. 14 at ¶ 2386)

         The Debtors are providers of laboratory-based diagnostic testing services that derive significant revenue from Medicare and Medicaid reimbursements. (D.I. 9 at ¶ 7) As such, they are subject to substantial regulation and oversight, including by federal and state agencies. (D.I. 14 at ¶ 107) As of early 2012, the United States Department of Justice (the "DOJ") was conducting joint criminal and civil investigations into Millennium (the "DOJ Investigation"). (Id. at A109) In the course of the DOJ Investigation (and prior to the issuance of the Credit Agreement), Millennium met with the DOJ "on numerous occasions" to discuss the allegations under investigation and produced to the DOJ approximately 11 million pages of documents. (Id.) In December 2014, the DOJ confirmed to Millennium that the DOJ would pursue claims against Millennium. (Id.) By February 2015, the Centers for Medicare & Medicaid Services ("CMS") notified Millennium that it was revoking Millennium's Medicare billing privileges based on billings submitted for 59 deceased patients. (Id.) On May 4, 2015, Millennium received a notification that its Medicare billing privileges would be revoked also on account of its alleged submission of fraudulent claims for services without valid physician orders. (Id.)

         On May 21, 2015, Millennium disclosed to its Lenders that it had entered into an agreement in principle with the DOJ, CMS, and various other government entities, to settle inter alia claims under the False Claims Act for Medicare fraud for a settlement payment of approximately $250 million. (See D.I. 14 at ¶ 867) On October 29, 2015, Millennium sought approval from its Lenders to restructure its debt obligations through either an out-of-court transaction or a prepackaged plan of reorganization. (Id. atA80) Consummation of an out-of-court transaction was not achieved. On November 10, 2015, the Debtors filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. Contemporaneously therewith, the Debtors filed their Plan (B.D.I. 14) and accompanying Disclosure Statement (B.D.I. 15).

         B. The Proposed Nonconsensual Third-Party Release and Related Provisions

         The Plan provided a basis for the continuation of the Debtors' business. Relevant to this appeal, the Plan also provided for a $325 million contribution by the Non-Debtor Equity Holders, specifically $178.75 million from MLH and $146.25 million from TA. Of the Non-Debtor Equity Holders' $325 million contribution, $256 million would fund Millennium's settlement of the DOJ's claims, $50 million would be paid to certain Lenders in exchange for their early commitment to support Millennium's restructuring, and the remaining $19 million could be used as Millennium operating capital. (D.I. 14 at ¶ 92, A94, A169-A170) In exchange for the $325 million contribution, the proposed Plan provided the Non-Debtor Equity Holders with full releases and discharges of any and all claims against them and related parties -including any claims brought directly by non-Debtor lenders such as Appellants - and including claims relating to the $1.3 billion special dividend that had been paid to the Non-Debtor Equity Holders while the Debtors were in the midst of the DOJ Investigation. (See B.D.I. 195-1, Plan at Art. X at H-K; D.I. 14 at ¶ 2208) The proposed Plan provided no ability for parties to "opt-out" of the third-party releases, meaning the releases would be granted upon confirmation of the Plan regardless of whether a creditor consented. (See Plan, Art. X at H-K) The proposed Plan also permanently enjoined Appellants from commencing or prosecuting claims released pursuant to the Plan against MLH, TA, or their Related Parties (as defined in the Plan). (See id.)

         C. The Fraud Action

         On December 9, 2015, prior to the plan confirmation hearing, Appellants filed a complaint in this Court (the "Fraud Action") against MLH, TA, TA Associates Management, L.P., and two corporate executives who are beneficiaries of the Plan's third-party releases, James Slattery and Howard Appel ("Defendants"). (See ISL Loan Trust v. TA Associates Management, L.P., et al, Civ. No. 15-1138 (GMS) (D. Del.)) The complaint demands a jury trial and asserts the following causes of action: (i) violation of RICO and conspiracy to violate RICO (18 U.S.C. §§ 1962(c) & (d)), based on allegations that Defendants engaged in fraudulent billing practices, including sending illegal reimbursement requests to Medicare and state Medicaid agencies; (ii) fraud and deceit based on intentional misrepresentation, aiding and abetting fraud, and conspiracy to commit fraud, based on allegations that Defendants made false and misleading representations, for the purpose of inducing Appellants to enter into the Credit Agreement, regarding the accuracy of Debtors' financial records, Debtors' compliance with applicable laws, and the existence of pending investigations and litigation against the Debtors; and (iii) restitution, based on allegations that, as a result of the fraudulent inducement, Defendants received a benefit of more than $100 million of loans issued under the Credit Agreement, which benefits Defendants have retained at Appellants' expense. (See Civ. No. 15-1138 (GMS), D.I. 7 (redacted complaint)) The Fraud Action is currently stayed pending the outcome of this appeal. (See id., D.I. 11)

         D. Appellants' Objections to Plan Confirmation

         Appellants raised a litany of objections to confirmation of the Plan. In addition to various objections regarding the content and adequacy of the Disclosure Statement, Appellants argued that the Bankruptcy Court lacked either "arising in" or "related to" subject matter jurisdiction to approve the nonconsensual third-party release contained in the Plan. (See B.D.I. 122 at 17-25; B.D.I. 174 at 4-9) Appellants further asserted that, even if the Bankruptcy Court had subject matter jurisdiction, the proposed approval of the releases under section 105(a)[11] of the Bankruptcy Code would contravene other sections of the Bankruptcy Code, including section 524(e), and hence the Bankruptcy Court lacked statutory authority to approve the release provisions.[12] (See B.D.I. 122 at 26-28) Appellants further argued that the Plan could not be confirmed unless it permitted creditors to opt out of the third-party release (see Id. at 29-31), and even if the Plan were so amended, exceptional circumstances did not exist to justify limiting the liability of a non-debtor to another non-debtor under Third Circuit law. (See Id. at 31-32 (citing In re Continental Airlines, 203 F.3d 203, 213, n. 9 (3d Cir. 2000) (“Continental II"))

         In pre-confirmation briefing, Appellants' Plan objection did no more than touch upon the Bankruptcy Court's lack of adjudicatory authority, in a section addressing its lack of subject matter jurisdiction (and seemingly conflating those concepts):

The jurisdiction of the Bankruptcy Courts is statutorily defined, and is confined to the boundaries of that statutory definition. Stern v. Marshall, 131 S.Ct. 2594, 2603 (2011) (noting that Bankruptcy Courts may only "hear and enter final judgments in all core proceedings arising under title 11, or arising in a case under title 11"); see also Wellness Int'l Network, Ltd. v. Sharif, 135 S.Ct. 1932, 1945 (2015) (observing that "bankruptcy courts possess no free-floating authority to decide claims traditionally heard by Article III courts"); 28 U.S.C. § 157(a). Rather, Bankruptcy Courts may only enter final judgments on non-core matters with the consent of the affected parties. Wellness, 135 S.Ct. at 1949. Because the Third-Party Release would impact direct, non-bankruptcy claims held by non-Debtors against other non-Debtors and which would not trigger the Court's jurisdiction, the Court does not have jurisdiction to approve the Third-Party Release without the consent of the Third Party Releasing Parties. [Appellants] have not given such consent.

(B.D.I. 122 at 17) (emphasis added)

         In response, Debtors accused Appellants of reading Stern too broadly, asserting instead that Stern had left intact the Bankruptcy Court's constitutional authority to approve the third-party releases. (See B.D.I. 131 at 17) Debtors argued that courts in this jurisdiction and others have rejected Stern challenges regarding the Bankruptcy Courts' constitutional authority, including in connection with the consideration and approval of nonconsensual third-party releases in a plan. (See Id. at 17-18) Debtors argued that adjudication of the Plan is "a unitary omnibus civil proceeding for the reorganization of all obligations of the debtor and disposition of all its assets" unique to bankruptcy and "not an ...

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