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25 March 2016
In In re Caesars Entertainment Operating Co v BOKF, NA(1) the US Court of Appeals for the Seventh Circuit reviewed a bankruptcy court's denial of a trustee's motion for a temporary injunction staying litigation between non-debtors.
The plaintiffs were banks that had loaned large sums to the debtor (CEOC) with the guaranty of its parent (CEC). They sued CEC, which was not a bankruptcy debtor, to enforce the guaranties that it had attempted to repudiate. However, CEC was also a defendant in the trustee's suit seeking to recover on behalf of the bankruptcy estate for fraudulent transfers carried out as part of an alleged scheme by which the parent or guarantor had sold CEOC's assets for less than their value and terminated its guaranties.
In support of the requested injunction, the trustee alleged that the effort to restructure CEOC in bankruptcy would depend on whether a substantial contribution could be extracted from CEC in an eventual settlement of the fraudulent transfer claims. However, the trustee complained that the banks' claims against CEC threatened to deplete CEC's resources and disable it from funding such a contribution. Relying on Section 105(a) of the Bankruptcy Code, the trustee moved the bankruptcy court to stay the banks' suit until 60 days after a bankruptcy examiner had made an independent assessment of the estate's claims, providing guidance to the parties, it was hoped, for negotiating a reorganisation plan. Section 105(a) has been described as an 'all writs' statute, empowering bankruptcy courts to issue temporary injunctions that are "necessary or appropriate to carry out the provisions" of the Bankruptcy Code.(2) The bankruptcy court construed Section 105(a) as authorising it to enjoin third-party litigation only if the suit to be enjoined arose out of the "same acts" of the non-debtor defendant that gave rise to disputes in the bankruptcy proceeding. Because the bankruptcy claims arose out of CEC's alleged fraudulent transfers, whereas the lender's claims were based on CEC's purported repudiation of guaranties, the bankruptcy court denied the injunction request as exceeding the bounds of Section 105(a). The district court affirmed.
On further appeal, the Seventh Circuit reversed. In an opinion written by Judge Richard Posner (a leading jurist who has authored a number of rulings on bankruptcy questions), the court accepted the premise that the bankruptcy proceeding and the lenders' suits did not involve "the same claims".(3) However, it held that the lower courts had construed too narrowly the equitable powers conferred by Section 105(a). The appellate court did not decide whether an injunction should have been issued against the lenders' suit, but vacated the decision below and remanded the matter for further proceedings consistent with a broader interpretation of the statutory injunctive power.
The Seventh Circuit read the authority conferred by Section 105(a) in light of the original bankruptcy jurisdiction of the federal courts. That jurisdiction is not confined to civil proceedings "arising under" the Bankruptcy Code or "arising in" a bankruptcy case, but rather, as the Seventh Circuit underscored, extends to all civil proceedings that are "related to cases under" the Bankruptcy Code.(4) "'[R]elated to' means 'likely to affect.'"(5) The appeal court did not have to search far to discern such a relationship: "If before CEOC's bankruptcy is wound up CEC is drained of capital by the lenders' suits to enforce the guaranties that CEC had given them, there will be that much less money for CEOC's creditors to recover in the bankruptcy proceeding".(6) The court considered the key question to be:
"whether the injunction sought by CEOC is likely to enhance the prospects for a successful resolution of the disputes attending its bankruptcy. If it is, and its denial will thus endanger the success of the bankruptcy proceedings, the grant of the injunction would, in the language of section 105(a), be "appropriate to carry out the provisions" of the Bankruptcy Code, since successful resolution of disputes arising in bankruptcy proceedings is one of the [Bankruptcy] Code's central objectives."(7)
In denying the injunction, the bankruptcy court had relied on Seventh Circuit precedents approving temporary injunctions under Section 105(a) where the enjoined suits between non-debtors arose from the same acts as claims that were being asserted by a bankruptcy trustee for the benefit of the estate and creditors generally.(8) In Caesars Entertainment the Seventh Circuit explained that although the 'same acts' predicate, where present, made out a more clear-cut case for a temporary injunction under Section 105(a), its absence did not necessarily preclude such an injunction.(9)
It might be asked why banks that prudently obtained the parent's guaranty should be prevented from exercising their rights against that non-bankrupt parent for the sake of promoting the trustee's chances of recovering for them and other lenders at the subsidiary level. In other words, if a lender stands in the dual capacity of creditor of the bankrupt subsidiary and creditor of the non-bankrupt parent, why should the lender be denied the full benefit of the latter capacity? Why, indeed, should civil courts vested with jurisdiction over the guaranty-plaintiffs' suits stay their hands just because the debtor chose bankruptcy and proceedings to enforce the guaranties were not unrelated to proceedings in the bankruptcy? Various answers – both favourable and unfavourable to the guaranty plaintiffs – are conceivable. But the Seventh Circuit stopped short of wading into these debates, leaving them to be argued in the bankruptcy court on remand. Instead, it articulated the root principle: "Though section 105(a) does not give the bankruptcy court carte blanche – the court cannot, for example, take an action prohibited by another provision of the Bankruptcy Code – it grants the extensive equitable powers that bankruptcy courts need in order to be able to perform their statutory duties."(10)
For further information on this topic please contact Trevor Swett at Caplin & Drysdale by telephone (+1 202 862 5000) or email (email@example.com). The Caplin Drysdale website can be accessed at www.capdale.com.
But when the question is whether other litigation undermines the viability of a bankruptcy reorganisation proceeding, precedent teaches that proof of irreparable harm or the inadequacy of remedies at law is "an unnecessary exercise" (Fisher v Apostolou, 155 F 3d at 882). What matters in that context is whether the other litigation would defeat or impair the bankruptcy court's jurisdiction over the reorganisation case.(Id) If so, the bankruptcy court may issue injunctive relief to foster good prospects for a successful reorganisation and thereby protect the public interest in fulfilling the purposes of the Bankruptcy Code.
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