Application of Bankruptcy's Automatic Stay to Actions Against Non-Debtors
Bankruptcy law protects debtors from ongoing and threatened actions by creditors, and protects creditors by preserving debtors’ assets for orderly distribution. At the heart of the bankruptcy system is the automatic stay provided by Section 362 of the Bankruptcy Code. Effective immediately upon the commencement of a debtor’s bankruptcy case, the automatic stay prohibits a wide range of actions affecting the debtor’s estate, including legal action against the debtor, enforcement of judgments against the debtor or against property of the estate, and acts to obtain possession of property of or from the debtor’s estate.
The automatic stay typically does not stay actions against non-debtors. Non-debtors at times, however, have sought protection under the automatic stay arising in a related entity’s bankruptcy case. While courts generally agree that, under exceptional circumstances, their equitable power authorizes their affording non-debtors protection under Section 362, courts vary in their willingness to exercise that power.
The Automatic Stay
The automatic stay is intended to protect a debtor’s assets, provide the debtor temporary relief from creditors, and facilitate the equitable distribution among creditors of the debtor’s assets by stopping the “race to the courthouse” typically occasioned by the debtor’s decline into insolvency. By its plain language, the automatic stay protects only debtors and their property, and rarely stays actions against co-tortfeasors or co-debtors who have not filed for bankruptcy protection.
Courts have recognized an exception justifying the extension of Section 362 protection to non-debtors, however, when “there is such identity between the debtor and the third party defendant that the debtor may be said to be the real party defendant and that a judgment against the third party defendant will in effect be a judgment or finding against the debtor.” For example, a court may stay an action against a non-debtor who has an absolute right of indemnity against the debtor. A court may stay an action against a non-debtor also when the action distracts the debtor’s key personnel so as to interfere significantly with the debtor’s ability to reorganize, or when the debtor is financially responsible for the non-debtor’s defense. Authority for so extending the automatic stay derives from the equitable powers granted courts by Section 105 of the Bankruptcy Code.
A bankruptcy court, however, will not interfere in an action against a debtor’s co-defendant if the co-defendant has no claim of indemnity against the debtor. Additionally, the mere right of a non-debtor surety or guarantor to assert a claim against the debtor following judgment against the non-debtor does not alone warrant extending the automatic stay to protect the non-debtor.
Kmart, Enron and W.R. Grace
Three recent cases have further explored the propriety of staying actions against non-debtors. In the Kmart Corporation chapter 11 case, a non-debtor joint venturer of Kmart, El Puerto Liverpool S.A. de C.V. (Liverpool) filed an adversary proceeding to stay state court litigation against Liverpool. Liverpool asserted that its and Kmart’s interests were so intertwined that the action against Liverpool was tantamount to an action against Kmart, and that the outcome of the state court litigation could threaten property of Kmart’s estate. Specifically, Liverpool asserted that it was entitled to indemnification from Kmart for any judgment against it, and that the state court litigation would interfere with Kmart’s reorganization.
The Kmart court rejected Liverpool’s argument. First, following the commencement of the bankruptcy case, the state court severed Kmart from the law suit. Accordingly, Kmart would not incur litigation costs, and, further, Kmart had no duty to pay Liverpool’s litigation costs in the suit. Additionally, since Kmart was no longer a party to the state court action, the doctrines of res judicata and collateral estoppel would not result in Kmart’s being bound by any judgment entered in that action. The Kmart court found that the state court litigation would not interfere significantly with Kmart’s reorganization, and rejected as overly speculative Kmart’s argument that the bad publicity resulting from the law suit would threaten its reorganization. Finally, the court was not moved by Liverpool’s argument that it would be unduly burdened by remaining as the sole defendant in the state court action. As the purpose of the automatic stay is the protection of Kmart and its creditors, the burden on Liverpool was irrelevant to the court’s decision whether to extend the automatic stay.
The Kmart court recognized the danger to Kmart that the findings and judgment in the state court action might be binding on Kmart, despite Kmart’s being severed from the case, under a joint enterprise liability theory. To protect Kmart, the Kmart court exercised its power under Section 105 to permanently enjoin all parties from asserting against Kmart any findings of fact, conclusions of law or judgment that might be entered in the state court.
More recently, the Fifth Circuit addressed the issue of extending the automatic stay to a non-debtor in connection with the Enron Corporation chapter 11 case. The dispute arose out of a netting agreement between Reliant Energy Services, Inc., on the one hand, and Enron and five subsidiaries, including Enron Canada Corporation, on the other. The netting agreement combined a number of underlying master agreements between the Enron entities and Reliant and provided that, if any one of the Enron entities defaulted on its obligations, Reliant could declare all of the master agreements in default and could take certain actions, including accelerating all obligations under the master agreements, exercising its rights of setoff, netting or recoupment, and retaining its collateral. Shortly prior to Enron’s bankruptcy, Reliant notified the Enron entities that one of the entities, Enron Power Marketing, Inc., was in default. After Enron filed bankruptcy, Reliant sued Enron Canada, the only Enron entity not in bankruptcy, in district court to recover $78.5 million, the aggregate obligation owed by the Enron entities. Reliant asserted that Enron Canada was jointly liable with the other Enron entities.
Enron Canada moved to dismiss the action, in part on the ground that the action was subject to the automatic stay in the Enron bankruptcy case. The district court agreed. The court reasoned that Reliant was attempting to avoid the automatic stay by limiting its collection efforts to Enron Canada, asserting joint liability against the only non-debtor Enron entity. Because the netting agreement did not impose upon the Enron entities joint liability, the court concluded, the law suit constituted “one of the ‘unusual circumstances’ where the automatic stay extends to a third party.” Consequently, the court dismissed the case.
On appeal, the Fifth Circuit Court of Appeals examined the netting agreement and concluded that the netting agreement was ambiguous as to whether the Enron entities could be held jointly liable, and that the district court failed to make the necessary findings as to the parties’ intentions so as to resolve the ambiguity. The court found that the district court based its decision to impose Section 362 to stay Reliant’s action against Enron Canada largely on its interpretation of the netting agreement. Because the netting agreement was ambiguous, the court of appeals vacated the district court’s order. The court of appeals instructed the district court to resolve the ambiguity and determine whether the netting agreement imposed joint liability. In the event Enron Canada is not jointly liable with the other Enron Entities, the automatic stay issue would be moot. If the netting agreement imposes joint liability, however, the district court then would need to revisit the automatic stay issue.
Even more recently, the United States Bankruptcy Court for the District of Delaware considered a summary judgment motion to dismiss debtors’ claims that the automatic stay should extend to a state court action against a non-debtor. Shortly after filing for relief under chapter 11, W.R. Grace & Co. and certain of its affiliates, including Grace Energy Company (GEC), filed an adversary proceeding to enjoin various actions, which allegedly implicated the debtors, their affiliates and their officers and directors. Included among the actions the debtors sought to enjoin was a state court action filed in Oklahoma, Exxon Corp. v. Samson Hydrocarbons Co. (the Oklahoma Action). Before the W.R. Grace court was a motion for summary judgment filed by ExxonMobil to dismiss the debtors’ claims that the Oklahoma Action should be stayed.
The Oklahoma Action arose from the following facts. A wholly-owned subsidiary of GEC, Grace Petroleum Company (Grace Petroleum) was one of several petroleum companies that had produced oil and gas at Cushing Field in Creek County, Oklahoma for many years. In 1985, ExxonMobil acquired the exploration rights to Cushing Field from Grace Petroleum. As a part of the transaction, Grace Petroleum agreed to indemnify ExxonMobil from damages relating to Grace Petroleum’s operations at Cushing Field. Subsequently, GEC sold Grace Petroleum to Samson Hydrocarbons Company (Samson) and pursuant to the stock purchase agreement, GEC agreed to indemnify Samson for certain environmental liabilities, including any liabilities relating to facilities that Grace Petroleum had previously owned.
Starting in 1990, several landowners made environmental claims against ExxonMobil relating to the operation at Cushing Field. ExxonMobil was able to settle these claims and proceeded to make indemnity claims against Samson. Samson refused to indemnify ExxonMobil and, consequently, ExxonMobil commenced the Oklahoma Action against Samson. GEC assumed the defense of the Oklahoma Action pursuant to its indemnity agreement with Samson. In April 2001, the debtors filed voluntary petitions commencing their chapter 11 cases. In the adversary proceeding commenced by the debtors shortly after the chapter 11 filings, ExxonMobil filed the summary judgment motion asserting that there was no basis for enjoining the Oklahoma Action by either extending the automatic stay or under section 105 of the Bankruptcy Code.
In considering the summary judgment motion, the W.R. Grace court acknowledged that although the automatic stay can be extended to protect non-debtors, such power must be reserved to the “most extreme and ‘unusual circumstances.’” In denying the motion for summary judgment, the W.R. Grace court determined that the facts of the case showed that “unusual circumstances” existed warranting the extension of the automatic stay. The debtors had acknowledged that the ExxonMobil action was covered by the indemnity that GEC had provided to Samson, the debtors had agreed to assume the defense of the Oklahoma Action and, in fact, GEC had assumed the defense of that action. Accordingly, the W.R. Grace court concluded that it would be hard pressed to find that debtors’ obligations under the Samson indemnity were anything but absolute, that a judgment against Samson in the Oklahoma Action would essentially be a judgment against the debtors and that debtors indemnity obligations, including its obligation to undertake the defense of the Oklahoma Action, will impair the debtors efforts to successfully reorganize. In addition to determining that the extension of the automatic stay was appropriate, the W.R. Grace court also determined that a stay of the Oklahoma Action was warranted under section 105.
Bankruptcy courts remain wary about extending the automatic stay to actions against non-debtors. Given the focus on potential liability of officers, directors and affiliates in connection with recent landmark bankruptcy filings, we likely will see more non-debtors seeking shelter under the automatic stay. Courts will not extend the automatic stay solely to protect a non-debtor. Likewise, courts are unlikely to stay actions against non-debtors absent a showing of some direct and immediate harm to the debtor or some material interference with the debtor’s ability to reorganize. Where such harm or interference is probable, however, courts will stay actions against non-debtors if doing so is necessary and appropriate to afford a debtor the relief intended by the Bankruptcy Code.
1. GATX Aircraft Corp. v. M/V Courtney Leigh, 768 F.2d 711, 716 (5th Cir. 1985)
3. A.H. Robins Co. v. Piccinin, 786 F.2d 994, 999 (4th Cir. 1986).
4. Id.; see also Pacor v. Higgins, 743 F.2d 984, 995 (3d Cir. 1984); Seybolt v. Bio-Energy of Lincoln, Inc., 38 B.R. 123 (D. Mass. 1984).
5. Gillman v. Continental Airlines, Inc. (In re Continental Airlines, Inc.), 177 B.R. 475, 481 (D. Del. 1993); American Imaging Serv., Inc. v. Eagle-Picher Industries, Inc. (In re Eagle-Picher Industries, Inc.), 863 F.2d 855, 860 (6th Cir. 1992).
6. Section 105 provides in part, “The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.“
7. Arnold v. Garlock, Inc., 278 F.3d 426, 435 (5th Cir. 2001).
8. Edwards v. Armstrong World Indus., Inc., 6 F.3d 312, 317 (5th Cir. 1993).
9. El Puerto de Liverpool S.A. de C.V. v. Servi Mundo LLantero, U.S.A., Inc. (In re Kmart Corp.), 285 B.R. 679, 683 (Bankr. N.D. Ill. 2002).
11. Id. at 689.
13. Id. at 689.
14. Id. at 691.
16. Id. at 690.
17. Id. at 692-93.
18. Reliant Energy Serv., Inc. v. Enron Canada Corp., 349 F.3d 816 (5th Cir. 2003).
19. Id. at 820.
20. Id. at 821.
21. Reliant Energy Serv., Inc. v. Enron Canada Corp., No. H-02-0706 p. 7 (D. Tex. Mar. 22, 2002) (Memorandum and Order)
22. Id. at p. 9.
23. Reliant Energy Serv., Inc., 349 F.3d at 821.
24. Id. at 825.
25. Id. at 826.
26. In re W.R. Grace & Co., et al., 2004 WL 954772 (Bankr. D. Del. 2004).
27. Id. at p. *2, citing McCartney v. Integra National Bank North, 106 F.3d 506, 510 (3d Cir. 1997).
28.. Id. at *4.