Caesars Entertainment: The Seventh Circuit Expands the Reach of § 105

The “automatic stay” is one of the most fundamental debtor protections under the Bankruptcy Code. On rare occasions, courts have used their equitable powers under Bankruptcy Code § 105 to enjoin actions against nondebtors, usually arising from the same litigation plaguing the debtor. In late 2015, the Seventh Circuit Court of Appeals decided Caesars Entertainment Operating Co. v. BOFK, N.A.[1] The decision, written by Judge Richard Posner, establishes a broad and flexible standard to be used by bankruptcy courts in deciding whether to enjoin actions against nondebtors, even where there is separate litigation involving different parties asserting different causes of action.

Caesars Entertainment Corp (CEC) owns, manages and operates casinos, and Caesars Entertainment Operating Company (CEOC) is a direct operating subsidiary of CEC. CEC guaranteed billions of dollars of loans to finance CEOC’s operations. When CEOC’s financial condition began to deteriorate, CEC transferred certain assets from CEOC to third parties and attempted to terminate the guaranties as a result of the transfers. In response, the guaranty-holders brought actions against CEC for $12 billion in damages in state court. In its bankruptcy proceeding, CEOC brought claims against CEC asserting that CEC caused the transfer of CEOC property to third parties for less than fair value in order to avoid liability on CEC guaranties.

CEOC, arguing that its reorganization depended upon a substantial contribution from CEC and fearing that the holders of guaranties against CEC would “jump the line in front of other creditors,” asked the bankruptcy court to enjoin the guaranty litigation until 60 days after a bankruptcy examiner appointed by the court completed an independent assessment of the bankruptcy claims. The bankruptcy court declined, ruling that exercise of powers under § 105 was applicable only if the nondebtor litigation arises from the “same acts” of the nondebtor that gave rise to the disputes in the bankruptcy case. The district court affirmed.

The Seventh Circuit disagreed. Judge Posner noted that the authority to use § 105 is not as limited as the lower courts suggested. While bankruptcy courts cannot use § 105 to take action prohibited by other sections of the Bankruptcy Code (citing Law v. Siegel),[2] § 105 grants extensive equitable powers to bankruptcy courts allowing them to fulfill their statutory duties.[3] Judge Posner established the following test for utilizing the injunctive powers authorized by § 105: (1) If the injunction of actions against nondebtors is likely to enhance the prospects of resolving the disputes attending the debtor's bankruptcy, and (2) if denial of the injunction would endanger the success of the bankruptcy proceeding, then granting the § 105 injunction would be appropriate to carry out the provisions of the Bankruptcy Code.[4] Applying the test, Judge Posner determined it appropriate to temporarily enjoin the guaranty-holders’ litigation. The breathing spell would allow analysis of the examiner’s report and provide the parties with the information they need “to have a clear shot at negotiating an overall settlement in what amounts to a three-cornered battle” over CEC’s assets.[5] To rule otherwise in this case would cause CEC to become a “badminton birdie” caught between the holders of CEC’s guaranties and CEOC’s fraudulent transfer claims.

In its analysis, Judge Posner discussed the two prior Seventh Circuit decisions upon which the bankruptcy court relied in denying the injunction under the “same acts” principle. The first decision, Fisher v. Apostolou,[6] involved claims of defrauded investors against the fraudster whose corporation was in bankruptcy and against a nondebtor futures commission merchant through which the fraudulent transactions were conducted. The Seventh Circuit upheld the bankruptcy court's injunction, noting that while the investor’s claims were not property of the estate, the claims were “to the same limited pool of money, in the possession of the same defendants, as a result of the same acts, performed by the same individuals, as part of the same conspiracy.”[7] Judge Posner said that while Fisher presented a more clear-cut case for § 105 relief, it did not follow that less clear-cut cases precluded relief. The temporary injunction in Fisher facilitated a prompt and orderly wind-up of the bankruptcy, and an injunction in Caesars Entertainment could do the same.[8] In the second case, Teknek,[9] the Seventh Circuit addressed a patent-infringement judgment against two companies, one of which filed bankruptcy. The bankruptcy trustee asked the bankruptcy court to enjoin the plaintiff from enforcing the judgment against the shareholders of the holding company, which the trustee asserted had looted both judgment defendants. The Teknek court ruled that, unlike Fisher, this case involved separate acts that caused separate injuries to separate companies, only one of which was in bankruptcy.[10] And because the entire judgment could be collected from the nondebtor defendant, there was no need for an injunction.

In contrast, as noted by Judge Posner in the Caesars Entertainment decision, the claims of the CEOC creditors and the guaranty creditors, whose direct loans to CEOC were supported by CEC guaranties, are not easily separable. If the guaranty creditors prematurely drain the assets of CEC, the creditors of the CEOC estate will realize less (perhaps much less) benefit from the fraudulent transfer claims. Thus, CEOC and its creditors have a direct and substantial interest in seeing the guaranty litigation temporarily enjoined.[11] Consequently, the Seventh Circuit found that the lower courts had misinterpreted Fisher and Teknek, so it remanded the case to the bankruptcy court to determine whether an injunction was appropriate. On Feb. 26, 2016, the bankruptcy court enjoined the guarantor creditors’ action against CEC.

Caesars Entertainment seems to set a lower bar for debtors to obtain an injunction of litigation against a nondebtor. Where the claims against the debtor and the nondebtor are related, if the injunction would facilitate resolution of disputes in the debtor’s reorganization — and, conversely, if denial of the injunction would endanger the debtor’s prospects for success — then the § 105 shield should be available to bankruptcy courts. While Caesars Entertainment is unique in that it involves billions of dollars of debt, loan guaranties by the owners of midsized and small debtors are ubiquitous. Where pursuit of the assets of the guarantor owner impairs the reorganization of the debtor, particularly where the estate may also have preference or other claims against the guarantor owner, lenders who relied upon the guaranty to protect themselves (without regard to their debtor’s bankruptcy) may find the guaranty much less valuable than they had anticipated.[12]