Co-defendant Injunctions The Non-debtor Stay

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Apr 1999

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To facilitate the bankruptcy process, the Bankruptcy Code stays various proceedings, thereby

providing a debtor with a reorganizational "safe haven." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §362(a)</a>. However, this stay

does not apply to non-debtor entities that are potentially liable for the debtor's debts. The

pursuit of these non-debtor entities can seriously affect a debtor's reorganization efforts.

Accordingly, many debtors and/or co-defendants lodge the argument that the same theory

supporting §362's automatic stay supports a stay of proceedings against non-debtor

co-defendants.<a href="#1" name="1a">1</a> To a creditor's dismay, these non-debtor entities may find refuge in §105(a)'s

broad grant of power, which includes the power to enjoin.

<h3>The Bankruptcy Court's Power Under §105</h3>

When Congress enacted §105(a), it intentionally granted bankruptcy courts broad authority

and power to act in furtherance of the bankruptcy process. Specifically, §105(a) states that

"the court may issue any order, process or judgment necessary or appropriate to carry out the

provisions of this title." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §105(a)</a>. The provisions of Title 11 and the court's power to

adjust the debtor-creditor relationship mandate such broad power and authority.

Although the breadth of §105(a) allows the court to act whenever necessary or appropriate,

§105(a) has limits. First, §105(a)'s own terms prohibit the court from affecting substantive

rights and remedies set forth in the Bankruptcy Code or the <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Rules of Bankruptcy

Procedure. Omni Mfg. Inc. v. Smith, 21 F.3d 660 (5th Cir. 1994)</a>. Thus, while Congress

created §105(a) to aid the enforcement of Title 11's rights and remedies, it prohibited any

change or creation of additional rights and remedies.

Second, non-Title 11 anti-injunction statutes also limit the court's power. For example, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…

U.S.C. §2283</a> prohibits a federal court from enjoining state court proceedings, though it excepts

injunctions necessary to aid the court's jurisdiction. Additionally, Congress has enacted other

more specific anti-injunction statutes. For example, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §7421(a)</a> prohibits the

injunction of tax collection efforts, and <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §104</a> prevents injunctions that otherwise

restrain proceedings involving labor disputes.

Despite such anti-injunction statutes and regardless of "other rights and remedies," §105(a)

allows the bankruptcy court to issue orders necessary to carry out the provisions of the Code.

Since the Code provides for the reorganization of a debtor's estate and the stay of proceedings

against a debtor's assets, §105(a) naturally grants the authority to issue injunctive relief

where necessary to aid in the reorganization process. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §105(a) (1999)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Corp.

v. Edwards, 514 U.S. 300, 115 S.Ct. 1493, 131 L.Ed.2d 403 (1995)</a>.

<h3>Situations Supporting Injunctive Relief</h3>

While §105(a)'s grant of power includes the power to enjoin, the question arises—what

circumstances support the issuance of an injunction? As stated above, injunctive relief is

appropriate where necessary to carry out the provisions of Title 11. Such circumstances

include situations where (a) creditors seek relief from a third party outside of bankruptcy, and

(b) where a creditor's action impairs the bankruptcy process.

<h3>Enjoining Creditors from Seeking Relief from Co-debtors</h3>

Often, non-debtor entities are co-liable for a bankrupt debtor's debts. Such co-debtors include

guarantors, sureties and insurance companies. More often than not, the co-debtor's liability is

inconsequential to the debtor. In other situations, an effective reorganization may necessitate

the protection of a co-debtor.

For example, since guarantors are often the debtor's insiders, such insiders are a potential

source of capital. However, an insider may lose the ability to fund a reorganization after a

finding of liability and entry of judgment. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Manhattan Bank v. Third Eighty-Ninth

Associates, 138 B.R. 144, 146-47 (S.D.N.Y. 1992)</a>. Further, participation in such lawsuits

may limit an insider's ability to meaningfully participate in the reorganization process. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=….

Robins Co. v. Piccinin, 788 F.2d 994, 1008 (4th Cir. 1986)</a>. Consequently, protecting insider

guarantors may enhance reorganization prospects, not to mention preventing res judicata. Since

reorganization theoretically provides for the creditor's claim, enjoining such lawsuits can be

just and fair.

Proceedings against sureties and insurance companies may also dictate issuance of an injunction

because of an estate's potential loss. For example, if the debtor and its management are insured

under the same insurance policy, management's liability may result in the debtor losing

coverage by the apportionment of the insurance policy, or because of indemnification

principles. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Floyd, 51 F.3d 530, 534 (5th Cir. 1995)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…. Robins Co. v. Piccinin,

788 F.2d 994, 1008 (4th Cir. 1986)</a>. Similarly, if the debtor and its management jointly paid

a surety bond, a plaintiff's recovery from that surety bond diminishes estate assets. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…

Corp. v. Edwards, 514 U.S. 300, 115 S.Ct. 1493, 131 L.Ed.2d 403 (1995)</a>.

Further, even though these types of actions are not directed at the debtor, collateral estoppel

may result in estate liability. Accordingly, actions against these co-debtors can affect the

debtor, the estate and the reorganization process. Thus, an injunction against such proceedings

is sometimes necessary to carry out the provisions of Title 11.

<h3>Enjoining Actions That Impair the Bankruptcy Process</h3>

In carrying out the provisions of Title 11, reorganization without disruption is essential.

However, disruption can come from more than just proceedings against estate assets. Other

proceedings, though not directly affecting estate assets, are often disruptive to the

reorganization process. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Johns-Manville Corp., 26 B.R. 420 (Bankr. S.D.N.Y. 1983)</a>.

For example, take the case of <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Aetna Casualty & Surety Co., 828 F.2d 1023 (4th Cir.

1987)</a>. In Oberg, asbestos plaintiffs attempted to remove the debtor from the lawsuit by suing

only upon insurance proceeds and by bringing suit only in states where no right to contribution

or indemnity existed. The plaintiffs argued that their lawsuits would not affect the debtor's

ability to reorganize.

Upon review, the Fourth Circuit stated that despite the plaintiffs' apparently benign attempts at

recovering from insurance, the litigation still dragged in the debtor because of the contractual

duty to aid in its defense, and because the debtor essentially possessed all the evidence. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v.

Aetna Casualty & Surety Co., 828 F.2d 1023, 1026 (4th Cir. 1987)</a>. The court further held

that the lawsuit was essentially against the debtor, even though nominally so, requiring the

debtor's participation and effort.

Thus, proceedings against third parties, though occurring outside the bankruptcy court and not

directed at the debtor, can still detrimentally affect the debtor's bankruptcy. Due to such

disruption, an injunction may be appropriate. However, anyone seeking an injunction must

show more than mere disruption to the bankruptcy; they must demonstrate that an injunction is

appropriate pursuant to certain established factors.

<h3>Injunction Factors</h3>

In demonstrating that an injunction is appropriate, courts consider more than mere necessity.

In fact, bankruptcy courts use the more standard factors for issuance of injunctions. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Zale

Corp., 62 F.3d 746 (5th Cir. 1995)</a>. These factors often do not support injunctive relief, no

matter how much the debtor thinks an injunction is necessary.

In issuing injunctions, courts typically consider (1) a substantial likelihood that the movant

will prevail on the merits, (2) a substantial threat that the movant will suffer irreparable

injury if the injunction is not granted, (3) that the threatened injury to the movant outweighs

the threatened harm an injunction may cause, and (4) the public interest. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Zale Corp., 62

F.3d 746, 765 (5th Cir. 1995)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Imaging Services Inc. v. Eagle-Picher Industries

Inc., 963 F.2d 855, 858 (6th Cir. 1992)</a>. While courts typically balance all four factors as

competing interests instead of prerequisites to issuance, some courts do not apply the "public

interest" factor and view it as an anomaly. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re L&S Industries Inc., 989 F.2d 929, 932 (7th

Cir. 1993)</a>.

Other courts ignore the traditional injunction factors and merely consider such notions as the

necessity of an effective reorganization or other Title 11 procedure. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Life Insurance v.

Ropes & Gray, 65 F.3d 973 (7th Cir. 1993)</a>. Such applications are rare and exist in few

jurisdictions, even though it provides an easier application than traditional factors.

Though applying traditional injunction factors is more difficult, it is not necessary to prove

every factor. These are merely factors for consideration. Consideration of each factor may also

weigh upon the degree of the previous factor. Thus, the most important argument at the

injunction hearing is that the facts require injunctive relief, even though one or more factors

are lacking in strength.

<h3>Conclusion</h3>

Though an extraordinary and often inappropriate remedy, the use of non-debtor injunctions can

greatly aid reorganization. Not only can injunctions protect estate assets, they also prevent

distractions from the reorganization process.

Further, non-debtor injunctions are strategic tools that may prevent a single creditor's

dominance. However, courts may disagree with an offensive use of injunctions. Therefore,

perhaps the most important thing to remember is that it is the bankruptcy court that has the

power to issue necessary and appropriate orders to enforce Title 11's provisions, based on the

court's views of what is appropriate, in light of all of the facts.

<hr>

<h3>Footnotes</h3>

<a name="1">1</a> Notwithstanding, of course, chapter 13's co-debtor stay, which is not the subject and focus of this article. <a href="#1a">Return to article</a>

Journal Authors

Bruce H. White

William L. Medford

Journal Date

Thursday, April 1, 1999 - 12:00