Two recent decisions involving health care companies demonstrate how reorganization under Chapter 11 of the Bankruptcy Code1 can be used to manage large liabilities.
Chapter 11 contains the provisions of the Bankruptcy Code that authorize bankruptcy courts to approve reorganization plans so that companies can continue in business with relief from life-threatening claims. Jurisdiction over bankruptcy matters is conferred on the U.S. district courts, which have the authority under 28 U.S.C. section 157(a) to refer any or all cases or proceedings to the bankruptcy courts. Such authorization typically takes the form of standing orders of reference, entered by the district courts, allowing bankruptcy courts to hear virtually all matters arising in a bankruptcy case. But because bankruptcy courts were created under Article I of the U.S. Constitution, rather than Article III, they lack authority to resolve certain disputes with finality. See Stern v. Marshall, 564 U.S. 462, 499, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011)2. If certain matters based on state law and involving private rights fall with the Stern proscription, a bankruptcy judge must, much like the process followed by magistrate judges, submit proposed findings of fact and conclusions of law to the district court for final determination. In addition, particularly since Stern, there have been additional challenges to the breadth of bankruptcy courts' jurisdiction.
The Third Circuit held in In re Millennium Lab Holdings II, LLC., 945 F.3d 126 (2019), that a bankruptcy court can, nevertheless, resolve a private dispute brought by non-parties to a bankruptcy case and who do not consent, when the issue would necessarily be resolved in the claims allowance process and was critical to the reorganization. Id. at 136. In addition, In re THG Holdings LLC, 2019 WL 6615341, at *4 (D. Del. Dec. 5, 2019), the Delaware District Court recently approved of the bankruptcy court's order in In re THG Holdings LLC, 2019 WL 4132666 (Bankr. D. Del. August 29, 2019, Judge Dorsey), which prevented Centers for Medicare and Medicaid Services (CMS) from withholding and offsetting approximately US$25 million in reimbursements due to True Health Diagnostics, which had been forced into Chapter 11 with its parent as a result of CMS's withholding of reimbursements during the prior two years. These decisions show that even though bankruptcy courts have limited jurisdiction, these courts can – with much impact on creditors' recoveries – fashion remedies to facilitate and protect reorganizations within their jurisdiction.
In Millennium Lab Holdings II, decided by the Third Circuit Court of Appeals on December 19, 2019, the court held that Millennium Labs' reorganization plan, which went into effect in December 2015 (the Millennium Plan), could release the debtors' shareholders, officers, and directors from state law fraud claims asserted by the debtors' lenders, notwithstanding that a significant lender did not consent and notwithstanding that the officers and directors were not themselves seeking bankruptcy relief. The Millennium Labs decision explains the circumstances in a reorganization case that give bankruptcy courts constitutional authority to approve and effectuate such a release of non-debtors from claims of third parties under state law, even when the putative plaintiff objects.
The Millennium Plan provided for a US$256 million settlement resolving, among other things, Medicare fraud and RICO claims asserted by governmental agencies (the Government Claims). The Plan also approved a US$325 million settlement between the debtors and shareholders, certain proceeds of which would be used to pay the Government Claims settlement and to provide US$50 million to certain pre-petition lenders in exchange for their support of the Millennium Plan. Other lenders (the Opt-Out Lenders) with claims against the debtors' owners and other non-debtors (including directors and officers) voted against the Plan and objected to the provisions of the Millennium Plan that released the shareholders and non-debtors, alleging that the equity owners had perpetrated an economic fraud on the bankruptcy court. The Opt-Out Lenders appealed from the confirmation of the Millennium Plan, and the case was remanded to the bankruptcy court for a determination of its constitutional authority to release the Opt-Out Lenders' state law fraud claims against the equity owners. After another appeal of the bankruptcy court's determination, the Third Circuit held that "a bankruptcy court is within constitutional bounds when it resolves a matter that is integral to the restructuring of the debtor-creditor relationship" if the "issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process." 945 F.3d at 136, citing Stern, 564 U.S. 462, 499 (emphasis added). The Third Circuit noted that it was not "broadly sanctioning..." nonconsensual third-party releases in bankruptcy reorganization plans" and specifically described the care taken by the bankruptcy court to review the evidence that made it clear that the Millennium Plan's release provisions were critically necessary to the debtors' successful reorganization. 945 F.3d at 139-40. To paraphrase, the circuit court held that granting the releases was within the bankruptcy court's constitutional power as a consequence of the well-reasoned and well-supported decision that but for the releases, Millennium's reorganization plan would have failed. See id.
In another Chapter 11 case, True Health Diagnostics and its corporate parent, THG Holdings, LLC, sought relief after being refused reimbursements by CMS for two years, during which CMS also failed to determine True Health Diagnostics' rights to reimbursements. In In re THG Holdings LLC, 604 B.R. 154 (Bkrtcy. D.Del. 2019), the debtor sought a preliminary injunction against CMS seeking to enforce the automatic stay and order CMS to release all Medicare payments until further order of court. CMS challenged the bankruptcy court's subject matter jurisdiction, asserting that the debtor's claims arose under the Medicare Act (42 U.S.C. sections 405(h) and 1395ii), since the debtor had not exhausted its administrative remedies. The court rejected this argument and instead found that the bankruptcy court had jurisdiction under 42 U.S.C. sections 157 and 1334.
Judge Dorsey of the Bankruptcy Court for the District of Delaware ordered CMS to pay approximately US$25 million due for reimbursement of its pre-petition services to patients. CMS had withheld these funds from True Health pending a determination of whether alleged pre-bankruptcy fraud by the debtor entitled CMS to retain these funds as overpayments. After navigating the similar, but distinct, legal concepts of set off and recoupment, Judge Dorsey concluded that CMS's post-petition withholding of reimbursements for medical tests performed by True Health post-petition based upon alleged pre-petition overpayments did not fall within the police power exception to the automatic stay. Importantly, amounts due to True Health from CMS were property of True Health's "estate" in the bankruptcy case because "the mere opportunity to receive an economic benefit in the future is property with value under the Bankruptcy Code." Id. at 160. Judge Dorsey further found that CMS's withholding of the post-petition Medicare payments was for no purpose other than "protecting its pecuniary interest in property of the estate over the interests of other unsecured creditors" and "CMS's actions ... to protect itself, based on its pre-petition claim" was within the prohibition of the Bankruptcy Code's automatic injunction. Id., at 161. When CMS later moved for a stay of the bankruptcy court's confirmation of the debtors' plan of reorganization to prevent the funds, from which CMS could otherwise be paid the full amount of its claim, from being distributed to the debtor's creditors, the Delaware District Court denied the motion. See In re THG Holdings LLC, 2019 WL 6615341 (D. Del. Dec. 5, 2019). That court agreed with Judge Dorsey that CMS's withholding was "action post-petition to obtain possession of the property of the debtors' estate by withholding payments for work performed by the debtors post-petition." Id., at *4.
In the Millennium Labs and THG Holdings cases, the opposing creditors clearly did not consent to the bankruptcy court's jurisdiction; nonetheless, the bankruptcy courts constrained the creditors' abilities to recover on their claims. These bankruptcy courts were held to possess the power to manage those claims by, in effect, enjoining the creditors' access to remedies otherwise available under non-bankruptcy law and by limiting recovery on the claims to the fund available for payment of unsecured creditors. These cases are significant because they show how the goals of reorganization can provide a basis for bankruptcy courts to use their jurisdiction to control creditors' access to remedies and to prioritize claims in order to facilitate reorganization, preserve a debtor's value, and obtain a fresh start for a debtor's business, even though bankruptcy courts are constitutionally limited forums.
1. Title 11 of the U.S. Code will be referred to as the "Bankruptcy Code."
2. Article III of the U.S. Constitution provides that judges of the federal district courts, circuit courts, and Smallreme Court are appointed by the President of the United States, have lifetime appointments, and their salaries cannot be reduced by acts of Congress. Because non-Article III courts do not offer the same assurances of an independent judiciary as Article III courts, bankruptcy courts have been held by the U.S. Smallreme Court to be unable to enter final orders on all of the same state law based and private claims that an Article III federal court may hear. See Stern 564 U.S. 462, 499. In order for a bankruptcy court to adjudicate claims that must normally be heard by an Article III court, the claim must fall within a recognized exception to Article III, and the most frequently used is the "public rights" exception. Cases within the public rights exception historically involved disputes "between the Government and persons subject to its authority in connection with the performance of the constitutional functions of the executive or legislative departments," Stern at 2612, but has more recently evolved to include cases involving rights "integrally related to particular federal government action." Stern at 2613.
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