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The Toolbox

Monday, August 29, 2011

Monthly column contributed by Judge D. Michael Lynn, United States Bankruptcy Court for the Northern District of Texas | Bloomberg Law

This month it’s time to talk about 11 U.S.C. § 105(a) of the Bankruptcy Code. I’ve postponed doing this because § 105(a) is all too often seen by attorneys as authority for the court to do . . . anything. I get motions seeking to sell property by authority of 11 U.S.C. § 363(b) . . . and § 105(a); or to reject a contract by authority of 11 U.S.C. § 365(a) . . . and § 105(a) – even though the former sections are quite sufficient for the movant’s purpose without resort to whatever muscle § 105(a) may have. Worse, I get parties asking for relief I can’t grant – for example, requiring a party to sell to the chapter 11 debtor in possession or granting blanket authority to pay prepetition debt, with only § 105(a) cited as authority.

Section 105(a) of the Code1 is a very important provision that gives the bankruptcy court the added authority and the flexibility to make effective the relief Congress intended to afford in bankruptcy cases. It is not, however, a “roving commission to do equity.” See United States v. Sutton, 786 F.2d 1305, 1308 (5th Cir. 1986). Nor is it an invitation to override the other provisions of the statute. Indeed, as I noted in my very first column, many Bankruptcy Code provisions contain their own allowance of flexibility. The words “unless the court orders otherwise” in provisions such as 11 U.S.C. §§ 348, 362(k) and 521, give the court the ability to fashion relief to suit the special situation.

There are situations, however, where § 105(a) is the proper basis for seeking relief. First, it may be used to fashion a mechanism to make other provisions of the Code work. Establishing a mandatory dispute resolution process for resolving mass tort claims is a good example of the use of this provision. See, e.g., In re A.H. Robins Co., Inc., 42 F.3d 870 (4th Cir. 1994) (describing bankruptcy and district court orders providing for a mandatory claims resolution facility). Another example is the appointment of a representative to act for unknown or future claimants. See, e.g., In re Johns-Manville Corp., 36 B.R. 743 (Bankr. S.D.N.Y. 1984) (appointing legal representative for asbestos-exposed future claimants of debtor corporation). Typically, when § 105(a) is used to justify relief of this sort, the relief must be tied to some other provision of the Code. Thus, initially, appointment of a legal representative for future asbestosis claimants was refused in the UNR case because the court did not think it served to carry out a provision of the Code. See In re UNR Indus., 29 B.R. 741, 744 (N.D. Ill. 1983) (denying debtors’ request to appoint a legal representative for future claimants, where debtors relied only on a leading treatise, and not on a provision of the Code in support of their request for relief).

A second major use of § 105(a) is to provide injunctive relief in addition to that afforded by the automatic stay. It is this area that I want to focus on this month. While § 105(a) might support numerous kinds of injunctive relief, including a mandatory injunction, I want to address injunctive relief to protect non-debtors, injunctive relief as to acts excepted from the automatic stay by 11 U.S.C. § 362(b), and injunctive relief as a safety net alternative to reliance on the automatic stay. These are the most common uses of § 105(a), and therefore the most useful tools for a practitioner.

Before dealing with specific reasons for injunctive relief, a few general remarks are in order. An injunction obtained under § 105(a) must be premised on the same showing as any injunction in a non-bankruptcy context. See In re Commonwealth Oil Ref. Co., 805 F.2d 1175, 1188-89 (5th Cir. 1986); see also S. Rep. No. 95-989, at 51 (1978) (stays or injunctions sought under § 105(a) “will be granted or issued under the usual rules for the issuance of injunctions”). Thus, the request for injunctive relief must meet the four prong test generally applicable under Federal Rule of Civil Procedures 65: the party seeking relief must show (1) likelihood of success on the merits; (2) likelihood of irreparable harm in the absence of preliminary relief; (3) that the balance of equities is in favor of the party requesting the relief; and (4) that the injunction is in the public interest. See Winter v. Natural Resources Defense Council, Inc., 555 U.S. 7, 20 (2008). Furthermore, the injunction must be sought through an adversary proceeding. See Fed. R. Bankr. P. 7001(7). Finally, if the relief is provided initially as a temporary restraining order (as is usually the case), it will expire no later than 14 days following issuance of the temporary restraining order unless continued after a hearing as a preliminary injunction (or unless the time is extended as permitted by law). See Fed. R. Civ. P. 65(a) and (b) (applicable in adversary proceedings via Fed. R. Bankr. P. 7065).

Incidentally, it is worth noting that, until 1973, when the first rules of bankruptcy procedure were adopted, most injunctive relief in bankruptcy cases was obtained through similar procedures. This accounts in part for the timing requirements of 11 U.S.C. § 362(e) and the allocation of the burden of proof on motions for relief from the automatic stay under 11 U.S.C. § 362(g).

Turning then, to injunctions staying actions against third persons, there are three frequently encountered situations where relief will be granted: (1) protection from suit for a person critical to the reorganization effort; (2) protection of a limited fund available to satisfy claims; and (3) protection of persons against claims for which the debtor will be ultimately liable. In each of these situations it is not the third party’s concerns that matter. Rather, it is the estate, the debtor or the rehabilitative process that must benefit by the injunction – only incidentally may the third party benefit. See In re Munoz, 73 B.R. 283, 285 (Bankr. D.P.R. 1987) (standing to enjoin the actions of a third party rests with the debtor, debtor in possession, or trustee, not with the liable third party); see also In re Consolidated Pioneer Mortg. Entities, 205 B.R. 422, 425 (B.A.P. 9th Cir. 1997). Thus, the debtor or trustee (usually) will be the plaintiff seeking relief, and the showing to the court must be that, absent the relief, there will be harm to the estate, the debtor or the reorganization process. See, e.g., In re Lomas Fin. Corp., 117 B.R. 64, 66 (Bankr. S.D.N.Y. 1990) (bankruptcy judge properly found that reorganization process would suffer irreparable harm were the lawsuit permitted to continue).

The first of these situations is typified by an injunction deferring suits against corporate officers during the corporation’s chapter 11 case. See, e.g., In re Ionosphere Clubs, Inc., 111 B.R. 423, 434-35 (Bankr. S.D.N.Y. 1990); In re Codfish Corp., 97 B.R. 132 (Bankr. D.P.R. 1988). The showing that must be made includes the necessity to the debtor’s reorganization of the efforts of the person to be protected and the likelihood that pursuing claims against the person will so distract him from his duties as to impair the reorganization. See Ionosphere Clubs, 111 B.R. at 435; In re Johns-Manville Corp., 26 B.R. 420, 426 (Bankr. S.D.N.Y. 1986), vacated in part by 41 B.R. 926 (S.D.N.Y. 1984). The entities enjoined will often – though not always – be pursuing claims for which the debtor is also liable. See, e.g., Ionosphere Clubs, 111 B.R. at 435 (a finding of liability as to debtor’s codefendants on a RICO conspiracy claim could be extended to debtor); Johns-Manville Corp., 26 B.R. at 426 (“[T]he suits being pursued against [debtor’s] officers and employees are in reality derivative of identical claims brought against [debtor].”).

The second fact pattern includes cases where claims covered by a fund – e.g., an insurance policy – exceed the amount of the fund. See, e.g., In re IFC Credit Corp., 422 B.R. 659, (Bankr. N.D. Ill. 2010); In re Quigly Co., Inc., 361 B.R. 670 (Bankr. S.D.N.Y. 2007) (allowing opportunity to seek relief from a preliminary injunction issued to prevent depletion of insurance policy). The fund, however, might be other than an insurance company’s exposure limit, as in, for example, Celotex Corp. v. Edwards, 514 U.S. 300 (1995). In such a case, the court must be shown that claims are likely to exceed available coverage, the result being unequal distribution of the estate among creditors. See In re SN Liquidation, Inc., 388 B.R. 579 (Bankr. D.Del. 2008); In re Metropolitan Mortg. & Securities Co., Inc., 325 B.R. 851 (E.D. Wash. 2005).

The third situation is where a claim made against a third party is subject to indemnification by the debtor or the debtor is otherwise obligated to satisfy the claim. For example, a tort claim asserted against the debtor’s employee for an act occurring in the course of employment. See, e.g., In re Philadelphia Newspapers, LLC, 423 B.R. 98 (E.D. Pa. 2010); In re North Star Contracting Corp., 125 B.R. 368 (S.D.N.Y. 1991); In re Johns-Manville Corp., 57 B.R. 680 (Bankr. S.D.N.Y. 1986). In such a case, the court will grant relief on the theory that not to do so will result in liquidation of a claim against the debtor in another forum and the necessity that the debtor satisfy the claim prematurely. See, e.g., In re Lomas Financial Corp., 117 B.R. 64, (Bankr. S.D.N.Y. 1990); In re W.R. Grace & Co., 315 B.R. 353 (Bankr. D.Del. 2004); Fleet Business Credit, LLC v. Wings Restaurant, 291 B.R. 550, (N.D. Okla. 2003).

A second area where injunctive relief under § 105(a) may be appropriate is in order to prevent actions regarding the debtor, its business, or the estate which are not barred by the automatic stay of § 362(a). The most obvious case is the suit commenced by the debtor and, therefore not stayed under § 362(a)(1). Such litigation may need to be stayed temporarily during the bankruptcy case, and § 105 may be invoked for that purpose.

More significantly, a number of acts are specifically excepted from § 362(a) by § 362(b). While § 105(a) may not be used to stay some of those acts (see, e.g., § 560 respecting swap agreements (excepted from the automatic stay by 11 U.S.C. § 362(b)(17)) as to which no court order may effect a stay), many other acts, for example by regulatory agencies, are not so protected. Simply because those acts are excepted from the automatic stay does not mean they may not be stayed. See In re Cajun Elec. Power Coop., Inc., 185 F.3d 446, 457 n. 18; Browning v. Navarro, 743 F.2d 1069, 1084, (5th Cir. 1984). Upon a showing that injunctive relief is warranted to protect the estate, the debtor or the reorganization process, an injunction against such an act may be obtained. See, In re Mirant Corp., 378 F.3d 511 (5th Cir. 2004); In re Alan I.W. Frank Corp., 19 B.R. 41 (Bankr. E.D. PA. 1982) (enjoining bad check prosecution where court found real motive was to obtain an order for restitution); In re Caldwell, 5 B.R. 740 (Bankr. W.D. Va. 1980).

The final area I want to address is really an extension of the prior area. While the 1984 amendment to § 362(a)(3)2, added “exercise [of] control over property of the estate” to prohibited conduct, expanded the scope of the automatic stay as well as explained its coverage, there still remain cases where it is unclear whether the automatic stay is applicable. The paradigm example of this is found in In re Prudential Lines, Inc., 928 F.2d 565 (2nd Cir. 1991). In that case, a parent company sought to take a worthless stock deduction on its federal income tax return that would have adversely affected the ability of the subsidiary to carry forward its net operating loss. Id. The bankruptcy court permanently enjoined it from doing so, finding that it would have constituted an action against the estate in violation of the automatic stay. Id. Although it was reasonable to argue that had the parent company taken a bad stock deduction that would have destroyed the debtor’s tax benefit and amounted to an exercise of control over estate property – especially given the Second Circuit’s opinion in In re 48th Street Steakhouse, Inc., 835 F.2d. 427 (2nd Cir. 1987) -- in order to be on the safe side, the creditors’ committee (the plaintiff in the adversary) sought to enjoin the parent under § 105(a).

This, then, is another use for that provision. If there is uncertainty about the applicability of the automatic stay, one should ask the court to rule on whether it is applicable, or, if the court concludes that the troublesome action does not fall within the purviews of § 362(a), to enjoin the act under § 105(a).

In sum, § 105(a) of the Code is an extremely useful and important tool, but it does not solve every problem. Just as a wrench should not be used as a hammer, and no tool will turn lead into gold, so there are limits on how § 105(a) can and should be used. The practitioner should keep those limits in mind.

Judge D. Michael Lynn

U.S. Bankruptcy Court

501 W. 10th St., Room 128

Fort Worth, TX 76102

D. Michael Lynn has served as United States Bankruptcy Judge for the Northern District of Texas in Fort Worth since 2001. During his tenure on the bench, he has presided over such large chapter 11 cases as Mirant Corporation and Pilgrim's Pride Corporation, as well as thousands of consumer cases. Prior to his appointment to the bench, he spent 29 years practicing bankruptcy law, specializing in corporate reorganizations. Judge Lynn was a Visiting Professor of Law at Southern Methodist University's Dedman School of Law for 15 years and now serves as Adjunct Professor of Law at Texas Wesleyan University, where he teaches courses in corporate reorganization law, legal drafting, and legal ethics. He has served as a contributing author for Collier on Bankruptcy and the Collier Bankruptcy Practice Guide, is presently co-author of The Collier Handbook for Trustees and Debtors in Possession, and has spoken frequently at continuing legal education events.



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