In a follow-up to his opinion in February declining to dismiss the chapter 11 case filed by an indirect subsidiary of Johnson & Johnson, Chief Bankruptcy Judge Michael B. Kaplan of Trenton, N.J., held that the bankruptcy court has power to impose a stay on states’ exercise of their police and regulatory powers, even though the continuation of the states’ suits is exempt from the automatic stay under Section 362(b)(4).
Background
Just before chapter 11 one year ago, Johnson & Johnson formed two new subsidiaries. LTL Management LLC was created to be the debtor, and the other took over J&J’s operating businesses. Two days later, LTL filed a chapter 11 petition in Charlotte, N.C. The bankruptcy judge in North Carolina transferred the case to New Jersey, where Judge Kaplan landed the dubious assignment.
LTL has no business operations of its own but assumed liability for all talc-related asbestos claims. J&J and the other non-debtor businesses agreed to supply the funds necessary for LTL to prosecute the reorganization and emerge from chapter 11.
The official committee representing talc claimants filed a motion to dismiss the chapter 11 case under Section 1112(b), contending that the filing was in bad faith. The U.S. Trustee supported either dismissal or appointment of a chapter 11 trustee. Judge Kaplan denied the motion on February 25. In re LTL Management LLC, 637 B.R. 396 (Bankr. D.N.J. Feb. 25, 2022).
Refusing to dismiss the case after a five-day trial, Judge Kaplan said that the chapter 11 filing “is unquestionably a proper purpose under the Bankruptcy Code.” Id. at 408. He also granted a preliminary injunction barring the continuation of lawsuits against the non-debtor J&J parent and affiliates. The talc claimants appealed directly to the Third Circuit, which heard argument on September 19. To read ABI’s report on the February 25 opinion, click here.
The Lawsuits by New Mexico and Mississippi
Before bankruptcy, the states of New Mexico and Mississippi had sued J&J, alleging that the sale of products laced with asbestos violated state laws prohibiting unfair trade practices and false advertising. Among other relief, the states sought money damages.
The debtor filed an adversary proceeding against the two states in June, asking Judge Kaplan for injunctive relief to stop the states’ lawsuits. The states opposed, contending that the suits were immune from the automatic stay as an exercise of governmental police and regulatory powers under Section 362(b)(4).
The Bankruptcy Court Has Jurisdiction
Judge Kaplan began with the debtor’s contention that the automatic stay applied, but first, he dismissed the states’ contention that the bankruptcy court lacked subject matter jurisdiction to issue or enforce a stay against them.
The states argued that the bankruptcy court had no subject matter jurisdiction because the bankruptcy court would have had no jurisdiction to preside over the police and regulatory enforcement actions. Judge Kaplan said that the proper focus was on the bankruptcy court’s jurisdiction over the adversary proceeding, not the suits in state courts.
Judge Kaplan found jurisdiction because the adversary proceeding “unquestionably” involves the automatic stay and whether it was “appropriate” to extend the stay’s protection to non-debtors. He held that the bankruptcy court had jurisdiction and that it was “core.”
Just in case, Judge Kaplan went on to find “related to” jurisdiction because the outcome might affect the debtor’s insurance coverage and its indemnification obligations.
The Automatic Stay
Next, Judge Kaplan examined whether it was “appropriate” to extend to the automatic stay to cover non-debtors.
Although the J&J entities named as defendants in the states’ suits were not in bankruptcy, Judge Kaplan found that the suits were, “fundamentally, an attempt to liquidate and recover claims against the Debtor.”
“Accepting the premise that [the] Debtor is a true defendant,” Judge Kaplan ruled that the automatic stay applied to the suits under Section 362(a)(1). Likewise, he held that the suits were enjoined as an act to obtain possession or control of estate property under Section 362(a)(3), given the “shared insurance policies” that would be invaded by a judgment.
Extension of the Stay
If the stay were not automatically applicable to non-debtors, Judge Kaplan confronted the question of whether there were “unusual circumstances” to warrant an extension of the stay to protect non-debtors.
Having held in his February 25 opinion that there is an “identity of interest” between the debtor and its affiliates, Judge Kaplan concluded that an extension of the stay was proper, because the suits would divert resources and “disrupt the flow of funds.”
Judge Kaplan also found that continuation of the actions against non-debtors “would impair mediation efforts and ongoing negotiations taking place within this bankruptcy.”
The Exception for Regulatory Actions
Although he found the automatic stay to apply, Judge Kaplan focused on Section 362(b)(4) to decide whether there was “any applicable statutory exception” allowing the states to continue their suits. The section provides that the automatic stay does not apply to “the commencement or continuation of an action or proceeding by a governmental unit . . . to enforce such governmental unit’s or organization’s police and regulatory power. . . .”
Judge Kaplan cited the advisory committee notes for saying that the exception should be given a “narrow construction.” The Third Circuit created two tests for the exception, “the pecuniary purpose and public policy tests.”
Because the suits were “proceedings related to public safety and welfare,” Judge Kaplan found with little hesitation that the exception to the automatic stay in Section 362(b)(4) did apply, even though the states also sought monetary damages. But, he said, the “conclusion does not end this Court’s inquiry,” he said.
Judge Kaplan found “nothing in the statute [that] prevents a court from imposing or extending the stay under § 362(a) subsequent to the filing.” Likewise, he found “nothing in the statute [that] precludes a bankruptcy court from issuing injunctive relief under § 105(a) enjoining the governmental unit’s proceedings where circumstances so warrant.”
Judge Kaplan found “that the exercise of the States’ police power seriously conflicts with the policies underlying the Bankruptcy Code.” He therefore held that “§ 362(b)(4)’s prevention of an ‘automatic’ stay upon the filing of the bankruptcy does not bar this Court from imposing or extending the stay under § 362(a), or otherwise restrict this Court’s ability to issue injunctive relief under § 105(a).”
A Section 105(a) Injunction
Judge Kaplan ended his 45-page opinion by finding justification and power for a non-debtor stay under Section 105(a) and the traditional rules for preliminary injunctions.
In that regard, he found that the debtor had a likelihood of success on the merits and had shown irreparable harm in the absence of stay. On the other hand, he saw only “minimal harm” to the states resulting from a stay.
In terms of public interest, Judge Kaplan said it would be “patently unfair to permit the States to proceed while others — particularly those who allege more direct, personal harm — must wait.”
The stay will not be open ended. Judge Kaplan said that he would “revisit continuation of the automatic stay” at a hearing in December.
In a follow-up to his opinion in February declining to dismiss the chapter 11 case filed by an indirect subsidiary of Johnson & Johnson, Chief Bankruptcy Judge Michael B. Kaplan of Trenton, N.J., held that the bankruptcy court has power to impose a stay on states’ exercise of their police and regulatory powers, even though the continuation of the states’ suits is exempt from the automatic stay under Section 362(b)(4).