Prepetition, Millennium Lab Holdings II, LLC, Millennium Health, LLC, and RxAnte, LLC (the Debtors) reached a settlement with various government entities (the USA Settling Parties) relating to, among other things, claims against the Debtors for violations of the Stark law, Anti-Kickback Statute and False Claims Act (FCA). The Debtors also negotiated a restructuring support agreement with an ad hoc group of lenders (the Ad Hoc Group) holding debt under a 2014 existing credit agreement in the original principal amount of $1.825 billion (the Credit Agreement). In re Millennium Lab Holdings II, LLC, 543 B.R. 703, 705 (Bankr. D. Del. 2016).

The terms of the settlements included: 1) a $325 million payment from the equity holders to the Debtors; 2) conversion of the Credit Agreement into a $600 million new term loan; 3) transfer of the Debtors’ equity interests to the lenders under the Credit Agreement (the Lenders); 4) creation of two trusts; 5) a $206 million payment to the USA Settling Parties; 6) full recovery for all creditors except the Lenders; and 7) non-debtor third-party releases (the Releases) of the Debtors’ equity holders and their officers and directors. Id. at 706.

Since the Debtors did not receive sufficient votes from the Lenders for an out-of-court restructuring, on Nov. 10, 2015, the Debtors filed petitions for Chapter 11 relief together with a proposed prepackaged plan (the Plan) in the United States Bankruptcy Court for the District of Delaware (the bankruptcy court). The Plan incorporated all of the terms of the prepetition settlements with the USA Settling Parties and the Ad Hoc Group, including the Releases. Id.

The Debtors provided disclosure of the Releases as follows: 1) including all Plan release provisions verbatim in bold typeface as an exhibit to the notice of hearing on confirmation of the Plan. In re Millennium Lab Holdings II, LLC, Case No. 15-12284, Dkt. No. 91, Ex. 2 (Bankr. D. Del. Dec. 10, 2015); 2) including the release provisions in the Lenders’ class 2 ballots (the “Class 2 Ballots”), id., Dkt. No. 16, Ex. A; and 3) using fully capitalized typeface in the Plan itself. Id., Dkt. No. 182-1, at 66-67. The Lenders were the only class entitled to vote on the Plan, id. at 27, and the Class 2 Ballots did not include an option to opt-out of the Releases. Id., Dkt. No. 16, Ex. A.

Some of the Lenders with claims against the Debtors’ equity holders and directors and officers voted against the Plan and objected to the Releases (the Opt-Out Lenders). On Dec. 10, 2015, an evidentiary hearing was held by the bankruptcy court to consider confirmation of the Plan. Id., Dkt. No. 190. The next day, the bankruptcy court made a lengthy oral ruling from the bench confirming the Plan and overruling the objections of the Opt-Out Lenders and the United States Trustee. Id., Dkt. No. 206 (the Hearing).

Oral Ruling

During Judge Laurie Selber Silverstein’s oral ruling, she first addressed the Opt-Out Parties’ assertion that the bankruptcy court did not have jurisdiction to approve the Releases. Judge Silverstein stated that bankruptcy courts have at least related to jurisdiction over third-party claims that could have an impact on the estate. Id. at 13:1-15. Here, the released parties had contractual indemnification claims and litigation advancement rights against the Debtors, which was a sufficient nexus to the Debtors’ estates, for the bankruptcy court to have jurisdiction to consider the Releases.

Second, Judge Silverstein addressed whether the Releases were appropriate under the circumstances. The Judge cited to In re Continental Airlines, 203 F.3d 203 (3d Cir. 2000), which “set forth what it called the ‘hallmarks’ of permissible, non-consensual releases; namely: Fairness, necessity to the reorganization, and specific factual findings to support the conclusions.” Judge Silverstein considered the following factors in analyzing the Continental hallmarks:

[1] An identity of interest between the debtor and the third party, such that a … suit against the non-debtor is, in essence, a suit against the debtor, or will deplete assets of the estate. [2] Substantial contribution by the non-debtor of assets to the reorganization. [3] The essential nature of the injunction to the reorganization, to the extent that, without the injunction, there is little likelihood of success. [4] An agreement by a substantial majority of creditors to support the injunction; specifically, if the impacted class or classes overwhelmingly votes to accept the plan. And [5] a provision in the plan for payment of all or substantially all of the claims of the … class or classes affected by the injunction. Hearing Tr. at 17:14-18:4.

Here, Judge Silverstein found that: 1) there was an identity of interest between the Debtors and the released parties due to the indemnification and advancement obligations owed by the Debtors should a nondebtor pursue a claim against the released parties; 2) the equity interest holders made substantial contributions by paying $325 million to the Debtors and relinquishing their equity interests in the Debtors, and the directors’ and officers’ sweat equity from their prior and future work for the Debtors was also a substantial contribution under the circumstances; 3) the Releases were essential to the Plan; 4) the support of 93.02% in number and 93.74% in amount of Class 2 Lenders was a substantial majority of creditors supporting the injunction; and 5) the $600 million new term loan, all the equity in the Debtors and recoveries under two trusts was reasonable compensation for Class 2 Lenders in exchange for the Releases, which is all that needs to be shown to satisfy the final factor.

Judge Silverstein stated that she was “not rejecting the argument that sweat equity alone may not be sufficient to constitute a substantial contribution in a given case. But in this case, where the record is unrebutted that the efforts of management successfully resulted in a viable plan that garnered support from all parties other than [the Opt-Out Lenders], and results in 100 percent payment to all creditors other than the [Lenders]; and that management, in the [Lenders’] view, is critical to unlocking the reorganized debtors’ total enterprise value, I find that the directors and officers have made a substantial contribution.”

After reviewing the relevant factors, Judge Silverstein approved the Releases, stating that “[t]aking into consideration the facts of this case, I find the releases and injunctions to all parties to be fair and necessary to the reorganization … . It is clear that the releases are necessary to both obtaining the funding and consummating a plan. In these cases, the funding does not merely enhance creditor recoveries; it is necessary for the [Debtors] to confirm the plan.”

The United States Trustee argued that there must be an ability to optout of releases contained in the Plan. In response, Judge Silverstein stated:

Here, the notice of non-voting status was served on all known non-voting classes … . That notice contained the full text, in bold, of the plan releases; thus, nonvoting creditors, including unsecured creditors, were on notice of the releases being granted and chose not to object. [G]iven the 100 percent payment on claims in this case, I find that the nonvoting parties have consented. Hearing Tr. at 27:22-28:5.

While Judge Silverstein confirmed the Plan without an opt-out mechanism, she stated that she could reevaluate this issue in future cases. Id. at 27:20-22.

Certification to the Third Circuit

Judge Silverstein certified the Opt-Out Lenders’ direct appeal to the U.S. Court of Appeals for the Third Circuit on the issue of what standard of law governs approval of “a non-debtor’s direct claims against other non-debtors for fraud and other willful misconduct without the consent of the releasing non-debtor … .”Millennium Lab, 543 B.R. at 709, 717. This issue met the requirements of direct certification because Judge Silverstein’s holding conflicts with Washington Mutual, 442 B.R. 314 (Bankr. D. Del. 2011). Id. at 714.

Unlike Judge Silverstein’s holding in Millennium Lab, Judge Mary F. Walrath stated in Washington Mutualthat a bankruptcy court “does not have the power to grant a third party release of a non-debtor. Rather, any such release must be based on consent of the releasing party (by contract or the mechanism of voting in favor of the plan).” Millennium Lab, 543 B.R. at 714-15 (quoting Washington Mutual, 442 B.R. at 352). While both cases recognized Continental, Judge Silverstein’s “interpretation of what is meant by Continental’s hallmarks — fairness and necessity to the reorganization — differs from that of theWashington Mutual court.” Millennium Lab, 543 B.R. at 715. However, the Third Circuit denied the petition for permission to appeal. In re Millennium Lab Holdings, No. 16-8017, Doc. No. 003112215428 (3d Cir. Feb. 22, 2016). Therefore, the Opt-Out Lenders were forced to file their appeal with the United States District Court.

Appeal to the District Court

The Opt-Out Lenders raised numerous issues on appeal of confirmation of the Plan, which is still pending before the district court. In re Millennium Lab Holdings II, LLC, Case No. 1:16-cv-00110(LPS), Dkt. No. 13, at 27-42 (D. Del. April 15, 2016). One of the issues on appeal is that the bankruptcy court erred in approving the Releases based on the facts of the case. The OptOut Lenders argue that the Plan does not provide for payment of all or substantially all of the Lenders’ claims, there is no identity of interest between the released parties and the Debtors because the released parties have no right to seek indemnification against the Debtors for willful misconduct claims, and the released parties are not contributing substantial assets. Id. at 45-58.

It is uncertain whether the issues raised on appeal by the OptOut Lenders will be decided by the district court. The Debtors filed a motion to dismiss the appeal on the grounds that the appeal is equitably and constitutionally moot, which the Opt-Out Lenders have opposed. In re Millennium Lab Holdings II, LLC, Case No. 1:16-cv-00110(LPS), Dkt. No. 7, 28 (D. Del. 2016). The district court scheduled a hearing on the Motion to Dismiss for Oct. 7, 2016. Id., Dkt. No. 41.

Practical Pointers

Prior to Millennium Lab, Washington Mutual provided precedent within the Third Circuit that a nondebtor third-party release could only be granted by a bankruptcy court based upon the affirmative consent of the releasing party. See Washington Mutual, 442 B.R. at 352. Millennium Lab now provides some authority for the position that bankruptcy courts can approve non-consensual third-party releases. Millennium Lab also provides new precedent for the proposition that directors’ and officers’ sweat equity alone could be enough to meet the substantial contribution factor in support of a nondebtor third party release.

However, practitioners should be careful in citing Judge Silverstein’s oral ruling as precedent in future cases. In fact, Judge Silverstein stated that “this ruling is not to be cited back to me. It may not even be persuasive in other cases, we’ll see.” Hearing Tr. at 5:3-4. The oral ruling needs to be considered in light of the circumstances that the bankruptcy court was faced with to confirm a plan prior to the expiration of a settlement deadline.

Judge Silverstein made it clear that she could reevaluate many of the issues decided in Millennium Lab, such as whether creditors must be given the ability to opt-out of non-debtor third-party releases contained in a plan, and whether sweat equity alone by directors and officers could be enough to weigh in favor of releases. Therefore, practitioners should carefully consider whether providing a mechanism for opting out of non-debtor third party releases is necessary and what consideration must be provided by officers and directors to support such a release in future cases. If nothing else, Millennium Lab provides a good example to debtors’ counsel of the notice that should be provided to all creditors should a plan provide for a non-debtor third-party release.

Reprinted with permission from the Volume 33, Number 12: October 2016 edition of the The Bankruptcy Strategist© 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.