Going Rogue: Revisiting Mediation and Preliminary Injunctions in Ch. 11

By Candice L. Kline and Jacob A. Mertus

Mediation is a fixture in chapter 11 cases, especially those involving mass torts.1 Debtors and their stakeholders often seek settlement of nondebtor litigation through mediation.2 Courts, many with local mediation rules, encourage this approach, viewing mediation as valuable to reaching plan confirmation.

Plan proponents likewise seek preliminary injunctions to bind nondebtors to the bankruptcy court’s mediation and plan-confirmation process.3 When successful, these nondebtor disputes funnel into bankruptcy and resolve there, but does coercive funneling into bankruptcy reduce mediation’s efficacy? Given that mediation is often mandatory, and nondebtors are usually enjoined, few opportunities exist to test the efficacy of mediation with and without injunctive relief.4

With bankruptcy courts readily granting injunctive relief, has bankruptcy practice made routine something that is considered “extraordinary” in civil cases?5 Revisiting blanket injunctive relief seems contrarian, but it might advance mediation outcomes.

Scrutiny of Preliminary Injunctions

Nonbankruptcy courts have questioned the granting of injunctive relief in Wellpath and Purdue. Their caution echoes such earlier cases as Aearo and Caesars, among others.

When Wellpath, a prison health care provider, filed for chapter 11, it immediately sought an emergency extension of the automatic stay to enjoin about 1,500 pending lawsuits against nondebtors, which the bankruptcy court granted.6 In one such nondebtor litigation case, after reviewing the bankruptcy court’s stay extension order, Hon. Kimberly G. Altman of the Eastern District of Michigan declined to enforce the stay-extension order issued by the U.S. Bankruptcy Court for the Southern District of Texas.7

Judge Altman’s analysis applied Sixth Circuit law and held that the automatic stay cannot extend to nondebtors.8 Section 105(a) undergirds bankruptcy courts’ injunctive powers.9 Wellpath’s Texas order had relied on § 362(a), omitted § 105(a), never mentioned preliminary injunction, and offered little analysis.10 In a different nondebtor lawsuit involving the same stay-extension order, the U.S. District Court for the Northern District of Ohio disagreed with Judge Altman, finding Wellpath’s order within the bankruptcy court’s authority and directing objections to the bankruptcy court.11 Wellpath’s amended order now references both Bankruptcy Code sections.12 After receiving many plan objections and public criticism, Wellpath revised its plan and is moving forward with solicitation and a confirmation hearing.13

In Purdue, an appeal of the extended injunction received scrutiny from the district court.14 District Court Judge Colleen McMahon observed the extensions of the treadmill challenge: It is hard to get off.15 Describing five years of extended preliminary injunction orders as “the elephant in the room,” she allowed the extension but cautioned that “there must be an end to this mediation process,” recognizing that extensions could become counterproductive.16

Purdue shows that when litigation occurs, a better deal may result.17 Improved settlements occurred twice following litigation pressure on the nondebtor Sacklers — after Judge McMahon’s confirmation reversal and again after the Supreme Court’s similar reversal.18 The appellate twists spurred further negotiations and improved settlements. Without compelled mediation through injunctions, would the initial plan have evolved more quickly, and at less cost? Did the injunctions give too much leverage to the plan proponents?

In Purdue, the Supreme Court’s majority signaled caution on key arguments used by plan proponents for injunctive relief. Arguments outside of the Code (e.g., unusual circumstances, with roots in bankruptcy superiority) seem disfavored.19 However, plan proponents have long embraced these arguments.20 In time, mandatory meditation enforced through preliminary injunctions could face more scrutiny.21

Likewise, the majority questioned indemnification liability arguments for enjoining nondebtor litigation. Agreeing with the U.S. Trustee, the majority observed that “bankruptcy courts have a variety of statutory tools at their disposal to disallow or equitably subordinate any potential indemnification claims.”22

Lastly, the majority limited § 105(a) “to ‘carry out’ authority expressly conferred elsewhere” in the Bankruptcy Code.23 Extending § 362(a) to nondebtors is questionable.24 Restraint over injunctive power could limit the funneling of nondebtor litigation into bankruptcy.25

Seventh Circuit Restraint

Seventh Circuit courts reluctantly enjoin nondebtors. For example, nondebtors in Aearo sought first-day injunctive relief.26 Arguments favoring the injunction centered on the “three i’s”: identity of interests, insurance and indemnification.27 A funding agreement let debtor Aearo request that nondebtor 3M satisfy its obligations.28

Aearo argued that bankruptcy was “the only avenue by which claimants may globally settle the Claims” vs. the ongoing multidistrict litigation (MDL).29 The U.S. Bankruptcy Court for the Southern District of Indiana hesitated to vanquish the MDL.30 Judge Graham acknowledged the MDL’s bellwether process as valuable to encouraging settlements.31

Judge Graham held that § 362(a)(1) does not apply to nondebtors, declining to follow out-of-circuit cases finding “unusual circumstances” to enjoin nondebtor litigation.32 The Seventh Circuit has not adopted the unusual-circumstances test.33

Judge Graham then concluded that § 362(a)(3) could not stay nondebtor actions based on insurance claims under the funding agreement and circuit precedent.34 The circuit’s narrow view of related-to jurisdiction also undermined injunctive relief.35 Reading related-to jurisdiction too broadly could easily snowball into “everything is [in some way] related to everything else.”36 Usual arguments on distraction and burden from continued litigation proved unconvincing, too.37 Looking for “extraordinary circumstances,” the court found none.38

The Aearo outcome recalls Caesars, where the U.S. Bankruptcy Court for the Northern District of Illinois denied § 105(a) injunctive relief to stay litigation against the nondebtor parent holding company.39 The debtors sought a mediation order, denied by Judge Goldgar.40 The court later approved voluntary mediation in parallel with plan confirmation.41 Signs of unease with injunctions and mediation remained, with the mediator later resigning amid the court’s “atypical views of a mediation process.”42

In Ceasars, Judge Goldgar first viewed § 105(a) injunctions are “more limited” and appropriate only when a “third party’s claims arise out of the same acts as claims the bankruptcy estate has against the [nondebtor].”43 He also held that insurance proceeds were not estate property.44 The debtors insisted that this was “a textbook case” for a § 105(a) injunction protecting a nondebtor guarantor funding the plan,45 but the court disagreed.46 The district court affirmed, agreeing that Seventh Circuit precedent did not permit enjoining nondebtor actions against guarantors under § 105(a).47 It demanded “something more” for an injunction.48

The Seventh Circuit criticized the “cramped interpretation” below.49 While not “carte blanche ... [§ 105] grants the extensive equitable powers that bankruptcy courts need ... to perform their statutory duties.”50 The Seventh Circuit vacated and remanded to determine whether the injunction would promote successful bankruptcy reorganizations.51

After remand, the bankruptcy court granted a consensual injunction.52 Voluntary mediation led to a restructuring-support agreement supported by all creditors except one.53 The last injunction order emphasized plan settlement and successful reorganizations.54 Although contentious, restructuring prevailed.

Bankruptcy’s Preliminary Injunction Test Too Loose?

Some courts pause before granting a preliminary injunction. Are they right? Could litigation encourage settlement? In Aearo, a $6 billion MDL settlement followed soon after losing the preliminary injunction bid.55 After appeals, Purdue also saw an improved settlement.

In civil cases, a plaintiff “must establish that he is likely to succeed on the merits, that he is likely to suffer irreparable harm in the absence of preliminary relief, that the balance of equities tips in his favor, and that an injunction is in the public interest.”56 The U.S. Supreme Court observed that “a preliminary injunction is an extraordinary remedy never awarded as of right.”57 The exercise of equitable powers should be pursued with care.58

In bankruptcy, debtors need not satisfy the traditional test.59 Irreparable harm is excused. Courts require less than clear evidence.60 Bankruptcy briefs use similar rhetoric warning of dire consequences from value-destructive litigation.61 Debtors using mirror-like conclusory arguments suggests looseness.62 Debtors argue for injunctive relief by showing a reasonable likelihood of a successful reorganization, risk of harm to the debtor’s estate without the injunction (the “three i’s” arguments) and the public interest (typically a circular reference to successful reorganization).63 The test is not rigorous.

Mediation of enjoined claims, it is argued, bolsters the chance for a successful reorganization.64 Injunctions issue if “continued litigation [against the nondebtor] would certainly impair ongoing mediation efforts and negotiations in the bankruptcy case.”65 In civil practice, no assurances exist to stay litigation during mediation or settlement negotiations, and settlements still regularly occur. Sustained pressure in bankruptcy likewise might improve settlement outcomes.

Conclusion

Bankruptcy courts often grant preliminary injunctions as routine, first-day relief, to funnel nondebtor litigation into bankruptcy. This practice might cause more harm than good. Injunctions might prompt more litigation and stall case progress. Mediation insulated by injunctions may progress slowly. A movement to require bankruptcy injunctions to follow civil practice might instead promote mediation efficacy and potentially fairness.66

Candice Kline is an assistant professor of law at the University of Toledo College of Law and counsel with Saul Ewing LLP, based in Chicago and Toledo, Ohio. Jacob Mertus is a third-year student at the University of Toledo College of Law.

Editor’s Note: ABI held a webinar shortly after the Supreme Court issued its decision in Purdue. To listen to the abiLIVE recording, please visit abi.org/newsroom/videos. ABI also published a digital book, The Purdue Papers, a compilation of 3,500+ pages of amicus briefs, petitions and other related background material. To order your downloadable copy, please visit store.abi.org.