X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
The automatic stay protects the debtor and its property from claims that are asserted or that could have been asserted against the debtor or its property pre-petition. However, situations arise where a debtor attempts to extend this automatic protection to certain nondebtor parties who have some relationship to the debtor and whose participation in or impact on the Chapter 11 process will affect the debtor’s reorganization. Parties who might have this type of relationship include nonbankrupt co-debtors, officers, directors, guarantors, sureties and insurers. As a result, the benefit of the automatic stay has been applied to nondebtors against whom a creditor may also have claims. APPLICATION OF SECTION 105(A) The U.S. Bankruptcy Code, 11 U.S.C. ��101-1330, provides a fundamental significant benefit to a debtor by automatically staying litigation upon the filing of a bankruptcy petition under 11 U.S.C. �362(a). That benefit is statutorily reserved solely for the debtor and only under special circumstances defined by the bankruptcy courts over recent years. Relief in instances where a debtor attempts to extend this automatic protection to nondebtor parties is afforded under 11 U.S.C. �105(a). Procedurally, the debtor seeks relief by way of the commencement of an adversary proceeding seeking injunctive relief under Rule 7001(9) of the Federal Rules of Bankruptcy Procedure. Section 105(a) of the Bankruptcy Code grants bankruptcy courts broad equitable power and authority to act in furtherance of the Code, providing that: “The court may issue any order, process or judgment that is necessary or appropriate to carry out the provisions of this title.” 11 U.S.C. ��101-1330. Notwithstanding this seemingly limitless power, Section 105 does have its boundaries. While it may not be used to affect the substantive rights and remedies of a party that can be specifically asserted under the Bankruptcy Code or the Federal Rules of Bankruptcy Procedure, Section 105 is a debtor’s tool of last (and sometimes first) resort to stop litigation between nondebtors dead in its tracks. Hence, Section 105 may be used, and has been used, to provide injunctive relief where creditors are attempting to assert claims outside of the bankruptcy proceeding against nondebtor parties or where the litigation by the creditors will impact negatively on the bankruptcy process unless it is stopped. Although the liability of a co-debtor may not be substantial, there are still instances where the debtor needs injunctive relief because the nondebtor party is (i) a potential source of capital that would disappear if a judgment were obtained against that nondebtor, or (ii) the nondebtor party is an officer, director or agent of the debtor, whose ability to participate in the reorganization process will be impaired if the nondebtor party is compelled to defend the action. See In re Third Eighty-Ninth Assocs., 138 B.R. 144 (S.D.N.Y. 1992). GUARANTORS One of the most common targets of a creditor is the guarantor of a debtor. The guarantor generally has limited resources that he might otherwise use to assist the debtor’s reorganization. Of course, when the guarantor has assets in excess of the amount intended to be used for the debtor’s reorganization, no third-party stay will be imposed. And, where there is insurance coverage for alleged misconduct of officers and directors, it has been argued that if the proceeds of the insurance coverage available — to both the debtor and its officers and directors — are dissipated to satisfy successful nondebtor claims, then those proceeds will not be available to the estate if needed down the road, thereby requiring a stay of such litigation. Furthermore, under principles of respondeat superior and collateral estoppel, if such litigation continues and the creditor prevails, the estate may be held liable without the opportunity to defend itself. Hence, the pursuit of such claims against nondebtor parties may thwart the bankruptcy reorganization process. In response, courts have enjoined the continued prosecution of this type of third-party litigation for a significant period of time and through the confirmation of a plan of reorganization. ESTATE PROPERTY NOT INVOLVED In In re A.H. Robins Co., 828 F.2d 1023 (4th Cir. 1987), the court granted a Section 105(a) stay even though estate property was not involved. Although the creditor plaintiffs agreed to refrain from discovery against the debtor in connection with the third-party litigation, the third-party defendants were not bound by that agreement. Hence, the insurer’s demand for discovery from the debtor would involve the debtor in the litigation nonetheless. The court found that the debtor’s involvement, albeit peripheral, and the potential interference with the reorganization efforts, justified the stay of the third-party action. EXTENSION OF INJUNCTIONS BEYOND MASS TORT CASES The need to protect nondebtor parties from prosecution of claims that would otherwise be enjoined (as to the debtor) by the automatic stay if brought against a debtor, finds its genesis in the mass tort cases. Section 105(a) grew out of the need to control massive nationwide product liability litigation and the race to see who would first reach the debtor’s limited pool of resources. These were indeed extraordinary cases requiring the extreme remedy of a nondebtor stay. In In re A.H. Robins Co., 788 F.2d 994 (4th Cir. 1986), before imposing a stay, the court required the presence of unusual circumstances such that the extension of the stay would avoid a “result that would be binding upon the debtor’s estate,” or would adversely impact the debtor’s ability to reorganize. However, the extension of the stay was not without concern; a stay under Section 105(a) essentially gave nondebtors the benefit of protection under Chapter 11, without the burden and obligations that arise from the filing of a Chapter 11 petition. The nondebtors were not under the scrutiny of the court, a creditors’ committee or the United States Trustee; and the nondebtors did not have to report or provide financial information to any party. Notwithstanding this concern, the rationale for staying actions against nondebtors has spiraled. Courts have extended injunctions to cases beyond the mass tort cases, such as securities fraud class actions or claims against partners of a debtor partnership, officers and directors of a debtor corporation, indemnitees and guarantors of a debtor. As a result, the Section 105(a) stay has become a very hotly contested issue. Most creditors dispute the nondebtor’s right to a stay. CREATION OF IMBALANCE The courts must not only consider the extent of any interference to the reorganization process brought about by the claim against the nondebtor party, but also whether the Section 105(a) stay is merely just a means to offer protection to those in control of a debtor (e.g., the officers and directors), or those whom the debtor wishes to protect (net of self-interest), with no other basis. The Section 105(a) extension of the automatic stay creates an imbalance where the Bankruptcy Code was designed to equalize the benefits and burdens to the parties in a bankruptcy proceeding. The debtor hopes for a successful reorganization, but exposes itself to many obligations and significant scrutiny as a result of filing for bankruptcy. On the other hand, a nondebtor, against whom actions may be stayed by Section 105(a), does not confront these obstacles, has no obligations and takes no risks, but enjoys the benefits afforded by a stay of litigation just like that offered to the debtor. Therefore, rather than merely extending the automatic stay as a matter of course to nondebtor parties who would benefit without further liability or risk, A.H. Robins and its progeny require that there be some exceptional or unusual circumstances to justify the stay. NOT AUTOMATIC The nondebtor stay cannot and should not be automatic. The massive asbestos litigation in In re Johns-Manville Corp., 26 B.R. 405 (Bankr. S.D.N.Y. 1983), resulted in numerous applications under Section 105(a) to stay litigation against nondebtor asbestos manufacturers and dealers. Although the court acknowledged the breadth of Section 105(a) to enjoin lawsuits against entities “inextricably interwoven” with or related to the debtor or the debtor’s property, relief under Section 105(a) was not available to them. However, in a subsequent proceeding in the Johns-Manvillecase, the court granted an injunction prohibiting actions against the officers, directors, employees, insurers, sureties and other agents of the debtor, because the lawsuits exposed the debtor to claims for contribution and indemnification and had a potential collateral effect. While some courts still tend to extend the stay in order to assist the reorganization process and to avoid inconsistent judgments against nondebtor parties which may result in collateral estoppel or otherwise bind the debtor in a later proceeding, courts generally will follow the A.H. Robinsstandard and require truly exceptional circumstances to allow a nondebtor to enjoy the benefits of the Bankruptcy Code without filing. With the growth of the use of the stay under Section 105(a), debtors have attempted to further extend the nondebtor stay to permanently enjoin actions against or release nondebtor third parties through a confirmed plan. Such nondebtor releases generally are prohibited under 11 U.S.C. �524(e). Certainly, the debtor’s discharge alone does not relieve a third party from independent liability to a creditor. Although broad, Section 105(a) does not authorize a court to grant relief that is inconsistent or contrary to the Bankruptcy Code. For example, Section 524(e) overrides the Bankruptcy Court’s otherwise super-equitable powers under Section 105(a) to prohibit permanent relief to nondebtors. Nevertheless, some courts have permitted these third-party releases or injunctions in favor of nondebtors, but only under certain conditions. LIMITS OF SECTION 105(A) Perhaps, the most extensive analysis of the limitation on the equitable powers provided by Section 105(a) is contained in the 3rd U.S. Circuit Court of Appeals’ decision in Gillman v. Continental Airlines( In re Continental Airlines), 203 F.3d 203 (3d Cir. 2000). In Gillman, the debtor, Continental Airlines, set forth a plan that provided for the release of its present and former directors and officers, and permanently enjoined lawsuits by the debtor’s shareholders currently pending against these officers and directors (nondebtors). The plan, as presented, effectively would have discharged the obligations of these nondebtors to the shareholders over the objections of the shareholders. The 3rd Circuit noted that Section 524(e) does not relieve a nondebtor of its obligations. “The Bankruptcy Code does not explicitly authorize the release and permanent injunction against nondebtors.” Although Section 105(a) “supplements” the Bankruptcy Court’s powers by granting it the authority to “issue any order, process or judgment that is necessary or appropriate to carry out the provisions of this title, � [i]t does not ‘create substantive rights that would otherwise be unavailable under the Bankruptcy Code.’” Prior to Gillman, it was not uncommon for debtors to attempt to release creditor claims against nondebtor defendants — usually officers and directors of the debtor corporation and accountants or other investment advisers — by trying to impose a permanent injunction on claims against these nondebtors or to grant releases to these nondebtors of such claims in the debtor’s plan of either reorganization or liquidation. Hence, not only was the creditor or shareholder prevented from pursuing a claim against the debtor (under Section 362(a)), but any attempt to recover based on independent claims against a directors and officers liability insurance policy (and available proceeds) was also destroyed. This is especially draconian in the case of a shareholder that may be receiving nothing in the way of a distribution through the bankruptcy proceeding. Acknowledging that the 3rd Circuit had not yet addressed this issue, the Gillmancourt reviewed and considered decisions by those circuits that had done so. The 9th and 10th Circuits have disallowed nondebtor releases and permanent injunctions. This appears to be the strictest approach. Other circuits use a more flexible standard. The 2nd Circuit permits releases and permanent injunctions involving claims against nondebtors where the enjoined party or forced-releasor receives some consideration for the rights it relinquishes. The 4th Circuit has approved nondebtor releases when consideration is provided and the releases are essential to the debtor’s reorganization. The foregoing flexible standard demonstrates that releases of nondebtors and permanent injunctions precluding claims against nondebtor parties require that the nondebtor who benefits therefrom must provide some form of consideration to the releasing party in order to obtain the relief. This appears to follow the “unusual circumstances” standard of A.H. Robins. The Gillmancourt concluded that the nondebtor releases and permanent injunctions contained in the Continental plan were not valid, even under the flexible standard. The court did not intend to set a standard for the allowance of permanent injunctions or third-party releases. Courts will need to attempt to balance the equities, especially where there are securities class-action claims asserted against a debtor’s former and current officers and directors. When imposing a Section 105(a) stay of the underlying securities class action (usually pending in a District Court), bankruptcy courts recently have fashioned the stay (i) to provide only short-term protection to permit certain discovery to continue, especially where it will not impede the debtor’s ability to reorganize, and (ii) to allow certain procedural motions and activity to take place so that the third-party litigation does not sit dormant during the Chapter 11 proceeding. By limiting the stay to a specific duration, courts recognize the need for plaintiffs with valid claims against a nondebtor third party to proceed eventually with their case. Hence, the application of the non-debtor Section 105(a) stay has evolved from the early mass tort cases, through the current plethora of class-action securities fraud and other litigation involving third parties related to the debtor. The language of Section 105(a) provides a debtor with an enormous weapon, but, like all weapons, it must be used with care. Courts will not grant even temporary injunctive relief without a showing of some extraordinary circumstances that warrant the extreme remedy of injunctive relief. And, for permanent injunctive relief there must be some form of meaningful consideration coupled with the necessity of the injunction for the debtor’s successful reorganization. Michael S. Etkin is a director and Ira M. Levee is of counsel in the bankruptcy, financial restructuring and creditors’ rights practice group at Lowenstein, Sandlerof Roseland, N.J.

This content has been archived. It is available exclusively through our partner LexisNexis®.

To view this content, please continue to Lexis Advance®.

Not a Lexis Advance® Subscriber? Subscribe Now

Why am I seeing this?

LexisNexis® is now the exclusive third party online distributor of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® customers will be able to access and use ALM's content by subscribing to the LexisNexis® services via Lexis Advance®. This includes content from the National Law Journal®, The American Lawyer®, Law Technology News®, The New York Law Journal® and Corporate Counsel®, as well as ALM's other newspapers, directories, legal treatises, published and unpublished court opinions, and other sources of legal information.

ALM's content plays a significant role in your work and research, and now through this alliance LexisNexis® will bring you access to an even more comprehensive collection of legal content.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2020 ALM Media Properties, LLC. All Rights Reserved.