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Each year, the EDPABC’s Education Committee formulates challenging hypotheticals based on recent case law. At the EDPABC’s Annual Forum, typically held in late-March/early-April each year, professors from local law schools facilitate lively discussions among EDPABC members about the hypotheticals in small-group breakout sessions. The hypotheticals are always engaging—and sometimes deliberately ambiguous—to mirror the complexity of everyday practice and foster debate among even the most seasoned bankruptcy professionals.
The hypotheticals are accompanied by summaries of the underlying case law and other relevant authorities inspiring the fact patterns. The summaries are intended to give readers insights into how similar issues have been argued before and decided by the courts and to inform their answers to the questions presented in the hypotheticals.
This hypothetical from a previous Forum, titled “Succession Planning in Legacy Media Conglomerates,” describes the fictional bankruptcy of a media conglomerate “Waystar/Royco” caused by massive tort liability resulting from a lack of confidence in news reporting due to officer and director meddling in the news stories the company published, as well as a Department of Labor investigation into its employment practices. The hypothetical raises questions around bankruptcy court jurisdiction over enjoining third-party litigation, assumption of executory contracts, violations of the automatic stay, and other issues.
Succession Planning in Legacy Media Conglomerates: Case Problem
Waystar/Royco (Waystar) is a multinational corporation headquartered in Philadelphia with multiple business lines, including cable news, theme parks, and cruise ship lines. Waystar was a public company, but the majority of its shares were owned through a holding company controlled by various trusts established by Waystar founder and CEO Logan Roy and his family.
In early 2021, Waystar’s flagship company, Waystar News (News), ran several stories about Cyberdyne Systems Inc., a prominent defense contractor. News’s two most prominent program hosts, Tom Tucker and Diane Simmons, each produced and ran multiple segments on their respective shows making incredible allegations that Cyberdyne was developing an artificial intelligence program that would control all nuclear weapons in the United States. Whether the allegations were true was widely disputed, but Congress banned the reported program under the TERMINATOR Act of 1985, and Cyberdyne’s share price plummeted.
Cyberdyne filed a defamation action against Tucker, Simmons, and News alleging $1 billion in damages. News immediately began paying all legal fees and expenses that Tucker and Simmons incurred in the defamation action, even though they did not have formal indemnification agreements with News. Instead, subject to exceptions for gross negligence or willful misconduct, News historically indemnified its employees in all defamation actions filed or threatened against them, including for their attorneys’ fees and costs, judgments, and settlements, as set forth in its employee policy manual and handbook.
Initial discovery in the defamation action revealed that Logan Roy had longstanding personal issues with certain members of Cyberdyne’s board of directors and had been influential in pushing News to run stories for several years attacking Cyberdyne and its board members. Emails showed that Tucker and Simmons initially had serious problems with the accuracy of their reporting on Cyberdyne, but that Roy ultimately persuaded them to follow through with their segments.
Cyberdyne’s action triggered the filing of a tidal wave of defamation actions against Tucker, Simmons, and News by various individuals and businesses who were aggrieved by News’s questionable coverage over the years. Overwhelmed by this litigation and because of the lagging performance of its other business lines, Waystar caused itself and each of its subsidiaries to file jointly administered chapter 11 cases in the Eastern District of Pennsylvania on December 1, 2021 (the Petition Date).
Question 1
Due to the volume of litigation and the resulting expense, News stops indemnifying Tucker and Simmons in all defamation actions, except Cyberdyne’s. However, News promptly files an adversary proceeding in its bankruptcy case seeking a preliminary and permanent injunction extending the automatic stay to protect non-debtors Tucker and Simmons from Cyberdyne’s defamation action, as well as from the other defamation actions.
An ad hoc committee of plaintiffs (the Ad Hoc Committee) objects to News’s request for a preliminary injunction. The Ad Hoc Committee asserts that the Court lacks subject-matter jurisdiction over the adversary proceedings necessary to enter the injunction. News argues that the Court has related-to jurisdiction under the “conceivable effects” test applied in Purdue Pharmaceuticals based on its indemnification obligations to Tucker and Simmons. The Ad Hoc Committee disputes that the indemnification obligations are sufficient to establish jurisdiction based on the elevated standard for related-to jurisdiction in the Third Circuit.
A: What arguments can News and the Ad Hoc Committee make to establish their respective positions? What arguments can News make to distinguish the Third Circuit’s standard, or persuade the Court to apply a lesser standard, and how should the Ad Hoc Committee respond? How should the Court decide these issues?
After hearing the parties’ arguments, the Court declines to apply the lesser standard from Purdue Pharmaceuticals and holds that News’s indemnification obligations do not establish related-to jurisdiction. However, it requests briefing from the parties on whether it has jurisdiction on any other grounds, including based on the risk that News will be bound by the factual and legal determinations decided in the actions against Tucker and Simmons (if they are not stayed) pursuant to collateral estoppel. The Court states that it will issue an oral ruling at a subsequent hearing on whether it will issue a preliminary injunction.
B: What arguments can the Ad Hoc Committee make against jurisdiction based on collateral estoppel? Does News have any alternative grounds to argue for related-to jurisdiction over the defamation actions?
After receiving the parties’ briefing, the Court schedules a hearing to announce its decision. It agrees with News that the Court has related-to jurisdiction. Further, the Court finds that grounds exist to extend the automatic stay to Tucker and Simmons, thus it reaches the question of whether News has satisfied the test for issuance of a preliminary injunction.
C. What factors should the Court consider in its ruling on whether failure to stay the defamation actions will cause irreparable harm to News? Is there a public interest in allowing the defamation actions to continue? What should the Court’s ruling be?
The purpose of this question is to elicit discussion of the issues raised in Union Trust Phila., LLC v. Singer Equip. Co (In re Union Trust Phila., LLC), 460 B.R. 644 (E.D. Pa. 2011); Int’l Union of Painters & Allied Trades Dist. Council No. 21 Health & Welfare Fund v. Ser. Painting, Inc., 2019 WL 2143370 (E.D. Pa. May 16, 2019); In re Fed.-Mogul Glob., Inc., 300 F.3d 368 (3d Cir. 2002); and Dunaway v. Purdue Pharms. L.P. (In re Purdue Pharms. L.P.), 619 B.R. 38 (S.D.N.Y. 2020).
Question 2
In the year before filing for bankruptcy, Waystar’s theme parks division, Waystar Parks (Parks), had commissioned a documentary about the origins of its amusement parks and how it had constructed its highlight attraction, “Way to the Stars,” an indoor rollercoaster that led its riders on a simulated voyage through space narrated by Tucker and Simmons. Naturally, Tucker and Simmons had also narrated the documentary, for which services they were entitled to 10 percent of the documentary’s profits for the first two years after its debut, as set forth in their “Documentary Narration Contracts.” Notably, the contracts included an additional covenant obligating Tucker and Simmons to appear at monthly events during that two-year period to promote the documentary in various markets around the United States. A separate provision of the contracts made it a condition precedent to all profit payments that Tucker and Simmons not be in breach of their obligations relating to the promotional events. However, the events could be cancelled by News at its sole discretion upon notice to Tucker and Simmons.
Against all odds and despite being critically panned, the documentary was a hit among the general public, generating incredible streaming revenue and giving rise to substantially greater profit obligations to Tucker and Simmons than expected. While it was preparing to file its bankruptcy case, News decided to withhold the profit payments it owed to Tucker and Simmons to generate additional case liquidity.
Shortly after the Petition Date, Tucker and Simmons file a motion to compel News to assume or reject the narration contracts, arguing that the contracts are executory and that if News desires to assume the contracts and continue streaming the documentary, the required cure costs include all outstanding profit payments.
- News opposes the motion, arguing that Tucker’s and Simmons’s promotional event obligations are not material unperformed obligations rendering the contracts executory. Tucker and Simmons respond that the terms of the contracts express the parties’ agreement that their promotional event obligations are material to News’s profit payment obligations, which they argue should control the question of materiality. What facts support and detract from their arguments? How should the Court rule? How could the contracts have xbeen drafted differently to potentially reach a different result?
- Would it comport with the policies underlying the assumption and rejection provisions of the Bankruptcy Code if the Court were to hold that the contracts were not executory? Would such a holding be fair to Tucker and Simmons?
- Assume that the promotional event obligations were material, but that the day before the Petition Date, News gave Tucker and Simmons notice that it was cancelling all remaining promotional events. Would the contracts still be executory? What arguments could Tucker and Simmons make?
The purpose of this question is to elicit discussion of the issues raised in Spyglass Media Grp., LLC v. Bruce Cohen Prods. (In re Weinstein Co. Holdings, LLC), 997 F.3d 497 (3d Cir. 2021); Gen. DataComm Indus., Inc. v. Arcara (In re Gen. DataComm Indus., Inc.), 407 F.3d 616 (3d Cir. 2005); and In re Sea Oaks Country Club, LLC, 2020 WL 6588412 (Bankr. D.N.J. 2020).
Question 3
Parks had always generated substantial revenue, but operated at a very low margin. Thus, over a period of several years before filing chapter 11, Parks began implementing extreme cost-cutting measures. As a result, Parks’ internal recordkeeping system degraded and its managers began pressuring employees to clock out, but continue working after their shifts ended, to avoid paying overtime. However, nine months prior to filing, Parks’ management endeavored to correct these issues, fixing its internal systems, and beginning to provide back pay to the hourly employees entitled to it, albeit in phases over twenty-four months to minimize the impact on its cash flows.
Parks was aware that it was under investigation by the Department of Labor and informed the Department of its efforts. However, the Department took two positions. First, it asserted that the phased back pay was unacceptable, and that Parks must make all back payments immediately. Second, the Department requested all relevant books and records from Parks to verify that every employee was receiving what they were entitled to.
Around the same time that Cyberdyne filed its defamation action against News, the Department filed an action against Parks in the United States District Court for the Western District of Pennsylvania, alleging that Parks violated the Fair Labor Standards Act by failing to pay adequate overtime wages and by failing to maintain proper records. The Department sought two injunctions, one requiring immediate payment in full of the back pay and another requiring Parks to turn over its books and records.
However, on the Petition Date, Parks files a suggestion of bankruptcy with the District Court. In response, the Department files a motion seeking a determination that its suit is not enjoined by the automatic stay, asserting that it falls within the police powers exception under section 362(b)(4).
- The Department argues that it is engaging in litigation to promote the government’s public policy interest in the general welfare of employees. Parks argues that the Department is using its police power to enforce the private rights of individual employees. Which argument is more compelling? Considering the District Court’s decision in Stewart v. Holland Acquisitions, Inc., should the automatic stay apply to the Department’s suit?
- Assuming Parks did cure the back pay fully, but still would not voluntarily turn over its books and records, is the injunctive relief sought by the Department proper?
The purpose of this question is to elicit a discussion of the issues raised in Stewart v. Holland Acquisitions, Inc., 2021 WL 1037617 (W.D. Pa. Mar. 18, 2021); and Chao v. Hosp. Staffing Servs., Inc., 270 F.3d 374 (6th Cir. 2001).
Question 4
Waystar also sells certain tech hardware, namely, set-top boxes for its proprietary streaming services. These boxes are manufactured by ABC Manufacturing pursuant to a Manufacturing and Shipping Agreement (the MSA), under which ABC will also receive boxes returned by Waystar for upgrades or repairs. Waystar’s payment terms under the MSA are 30 days from the invoice date. ABC used a third-party vendor, XYZ Logistics, to store and ship Waystar’s boxes, pursuant to a Warehousing and Shipping Agreement (the WSA).
Several months before the Petition Date, Waystar began missing payments, which constituted defaults under the MSA. Around the same time, Waystar also returned approximately 15,000 boxes, worth a total of $1.5 million, to ABC for upgrades as part of a new design intended to help Waystar compete with Amazon’s Firestick. Based on Waystar’s defaults, ABC exercised its remedies under the MSA to require that Waystar pay for the upgrades and shipping on cash-in-advance terms. Waystar complied. However, by the time the upgrades to the boxes were completed and the boxes were transported to XYZ’s warehouse, but before the Petition Date, Waystar had accrued a substantial unpaid arrearage on orders it had placed for new boxes. Accordingly, ABC directed XYZ not to ship the upgraded boxes to Waystar, as permitted under the MSA and WSA.
After the Petition Date, Waystar sends a letter to ABC demanding that it release the hold it placed on the upgraded boxes and have them shipped to Waystar. Because Waystar still owes a substantial pre-petition arrearage on its orders for new boxes, ABC sends a response opposing Waystar’s request to release the hold and stating that it will not have the boxes shipped to Waystar. Both Waystar and ABC copy XYZ on their correspondence.
- Waystar files a motion requesting damages for a willful violation of the automatic stay against ABC, arguing that its refusal to release the hold and have the upgraded boxes shipped to Waystar constitutes an act to collect a debt in violation of section 362(a)(6). What arguments should the parties make as to the alleged stay violation? How should the Court rule?
- Assume that the Court holds that ABC’s refusal to release the hold and ship the upgraded boxes to Waystar violated the automatic stay. ABC argues that in light of the Supreme Court’s decision in City of Chicago v. Fulton, it had acted in good faith in its belief that it was not violating the automatic stay. Is ABC correct in its position that even if it violated the automatic stay, it did not commit a willful stay violation?
The purpose of this question is to elicit discussion of the issues raised in Cal. Coast Univ. v. Aleckna (In re Aleckna), 13 F.4th 337 (3d Cir. 2021); City of Chicago v. Fulton 141 S. Ct. 585 (2021); Margavitch v. Southlake Holdings, LLC (In re Margavitch), 2021 WL 4597760 (M.D. Pa. Oct. 6, 2021); and Cordova v. City of Chicago (In re Cordova), 2021 WL 5774400 (Bankr. N.D. Ill. Dec. 6, 2021).
Authority Summaries for Question 1
Union Trust Phila., LLC v. Singer Equip. Co (In re Union Trust Phila., LLC),
460 B.R. 644 (E.D. Pa. 2011)
Background
In April 2009, Singer Equipment Company, Inc. sued Chestnut Restaurant Ventures, LLC (CRV), along with Joseph Grasso and Garrett Miller as members of CRV, in the Court of Common Pleas of Philadelphia for amounts allegedly owed for purchases of restaurant equipment. In August 2010, CRV transferred all of its assets, including the equipment interests, to another entity owned by Grasso and Miller, Union Trust Philadelphia, LLC.
In March 2011, Union Trust filed for bankruptcy under chapter 11 in the Eastern District of Pennsylvania. Shortly thereafter, the Court of Common Pleas entered a judgment enforcing a settlement agreement among the parties to the state court proceeding, from which judgment Grasso and Miller appealed. Union Trust then commenced an adversary proceeding against Singer, seeking an injunction under section 105(a) of the Bankruptcy Code to enjoin the state court proceeding and extend the automatic stay under section 362(a) to Grasso and Miller. The Bankruptcy Court granted a preliminary injunction that would expire at the end of August 2011 to provide Union Trust with sufficient time to prepare and submit a plan of reorganization. Singer appealed to the District Court.
Analysis
The District Court followed the three-step analysis from In re Philadelphia Newspapers, LLC, 407 B.R. 606 (E.D. Pa. 2009), to determine if the preliminary injunction was properly issued by the Bankruptcy Court. Under the three-part analysis, the District Court must determine whether the Bankruptcy Court (1) “had jurisdiction to issue the injunction,” (2) “properly extended the § 362(a) stay” to the non-debtor parties, and (3) “properly exercised its discretion in issuing the injunction pursuant to section 105(a).” The District Court emphasized that, “[u]nless all three steps of the analysis are satisfied, an injunction should not issue.”[1]
Jurisdiction
First, the District Court discussed whether the Bankruptcy Court had jurisdiction to issue the injunction. A bankruptcy court has jurisdiction to enjoin proceedings between third parties only if those proceedings arise in, arise under, or are related to the underlying bankruptcy. Related-to jurisdiction exists where “the outcome of that proceeding could conceivably have any effect on the estate being administered in bankruptcy.” Pacor v. Higgins, 743 F.2d 984, 994 (3d Cir. 1984).
“[T]he parties principally dispute[d] whether the Bankruptcy Court had ‘related to’ jurisdiction over the state court proceedings.” Union Trust argued that the Bankruptcy Court had related-to jurisdiction because the state court proceeding triggered a contractual provision requiring indemnification of Grasso and Miller. Union Trust also argued that the Bankruptcy Court had related-to jurisdiction because the state court proceeding would impact its reorganization efforts and the value of its assets. In response, Singer argued that the Bankruptcy Court lacked related-to jurisdiction because, “contrary to Union Trust’s contention,” Union Trust was not obligated to indemnify Grasso and Miller. Further, even if it were so obligated, Union Trust’s indemnification obligations would not “sufficiently affect the administration of the bankruptcy estate.”
The District Court found that while Union Trust might have owed indemnification obligations, that was insufficient on its own to establish related-to jurisdiction. “A bankruptcy court lacks ‘related to’ jurisdiction over a third-party action ‘if the only way in which that third-party action could have an impact on the debtor’s estate is through the intervention of yet another lawsuit.’” Thus, common law indemnity obligations would not establish related-to jurisdiction. Further, “while a contractual right to indemnity may present ‘a more direct threat’ to reorganization,” even contractual indemnification obligations do not “in all cases” establish jurisdiction. Whether they do depends on “a fact-specific, case-by-case basis.”
Union Trust’s purported indemnification obligations were set forth in its Operating Agreement. Singer argued that the relevant provision only entitled Grasso and Miller to indemnification for costs incurred because of actions taken in connection with the performance of their duties to Union Trust. Despite their testimony on the issue, and the fact that Union Trust had already been paying Grasso’s and Miller’s legal fees for the state court proceeding pre-petition, the District Court concluded that the “limited record” concerning the indemnity did not allow it to determine whether state court proceeding was within the scope of the indemnification provision in Union Trust’s Operating Agreement. Therefore, the Bankruptcy Court did not have related-to jurisdiction based on Union Trust’s indemnification obligations.
However, the District Court still found that the state court proceeding would have an impact on Union Trust’s reorganization efforts sufficient to establish related-to jurisdiction.
First, the District Court agreed with Union Trust’s argument that Grasso and Miller were crucial to the reorganization efforts and that continuation of the state court proceeding would therefore adversely impact the reorganization by consuming their time and resources. For example, both were actively involved in obtaining financing for the reorganization, guaranteed a loan commitment to help fund the reorganization, and made “substantial” payments on behalf of Union Trust since the bankruptcy filing. Further, Grasso and Miller extensively participated in Union Trust’s operations and daily business decisions.
Second, the District Court credited Union Trust’s argument that, “if the state proceedings are allowed to continue, it could be barred from relitigating issues decided in those proceedings by operation of collateral estoppel.” Indeed, because of their “prior legal or representative relationship,” the District Court found privity between Union Trust, Grasso, and Miller sufficient to preclude Union Trust from relitigating the state court’s factual and legal determinations even though it was not a party to that proceeding.[2]
Accordingly, the District Court held that “Union Trust’s potential indemnification obligations and the impact on Union Trust’s reorganization efforts, taken together, provide an adequate basis for the court to find that the state court proceedings are sufficiently ‘related to’ the underlying bankruptcy.” The Bankruptcy Court therefore had jurisdiction to issue the injunction.
Extension of Stay
Next, the District Court discussed whether the Bankruptcy Court properly extended the automatic stay to Grasso and Miller. The automatic stay under section 362(a) only stays actions against a debtor, but can be extended to non-debtor third parties if “unusual circumstances” exist. Unusual circumstances exist where either (1) “there is such identity between the debtor and the third-party defendant that the debtor may be said to be the real party defendant and that a judgment against the third-party defendant will in effect be a judgment or finding against the debtor” or (2) “stay protection is essential to the debtor’s efforts of reorganization.”
The District Court found the second situation to be present due to the involvement by Grasso and Miller in the restructuring efforts. Similar to its finding that the Bankruptcy Court had related-to jurisdiction, the District Court relied on the active involvement of both Grasso and Miller in the case and financial support and assurances of Union Trust to be essential to restructuring efforts and without such, Union Trust’s ability to reorganize would diminish. However, the District Court also found that “the record supports the existence of an identity of interests among Union Trust, Grasso, and Miller,” because Union Trust was “potentially obligated to indemnify them in connection with [the state court] proceedings.” Thus, the Bankruptcy Court properly extended the automatic stay to Grasso and Miller.
Injunction Pursuant to Section 105(a)
Finally, the District Court discussed whether the Bankruptcy Court properly exercised its discretion to issue the injunction under section 105(a). The District Court recited a four-factor test for issuance of a preliminary injunction: “(1) whether the movant has shown a reasonable probability of success on the merits; (2) whether the movant will be irreparably injured by denial of the relief; (3) whether granting preliminary relief will result in even greater harm to the nonmoving party; and (4) whether granting the preliminary relief will be in the public interest.”
The District Court held that the Bankruptcy Court did not abuse its discretion to issue a preliminary injunction under these factors. First, Union Trust showed that a successful reorganization was viable because it had negotiated cash collateral agreements, was making adequate protection payments, and continued to operate its restaurant. Second, Union Trust showed that there would be irreparable harm in the absence of an injunction because it would diminish Grasso’s and Miller’s ability to assist in reorganization. Third, the District Court found that the injunction would not cause greater harm to Singer, as the injunction was of limited duration and the Bankruptcy Court would revisit the continuation of the injunction if necessary. Further, Singer failed to identify any harm that would be caused by the injunction. Finally, the District Court found that the preliminary injunction was in the public interest because it protected the reorganization and claims resolution process, and the success of reorganization would be hindered without staying the state court proceeding.
Conclusion
The District Court held that the Bankruptcy Court had jurisdiction to issue the preliminary injunction, the Bankruptcy Court’s finding of unusual circumstances to extend the stay was not clearly erroneous, and the Bankruptcy Court did not abuse its discretion in issuing the injunction.
Int’l Union of Painters & Allied Trades Dist. Council No. 21
Health & Welfare Fund v. Ser. Painting, Inc.,
Civ. No. 18-3480, 2019 WL 2143370 (E.D. Pa. May 16, 2019)
Background
The international Union of Painters and Allied Trades District Council 21’s Employee Fund (the Funds) sued Service Painting, Inc., as well as its president and main shareholder, Nick Garavelas, under the Employee Retirement Income Security Act (ERISA). Service Painting and Garavelas failed to respond to the complaint and, when the Funds moved for default judgment, Service Painting filed for chapter 11 relief. As a result, the court placed the case in suspense.
The Funds thereafter moved to re-open the ERISA case against Garavelas only, as he was a non-debtor and therefore not subject to the automatic stay. Garavelas failed to respond to the motion and the court set a damages hearing. After Garavelas’s counsel entered an appearance and a negotiation took place, the Funds withdrew their default motion, expedited discovery took place, and the damages hearing was reset. After the hearing, the court ordered the Funds to show cause why the court could proceed against Garavelas individually.
Analysis
Garavelas argued that the automatic stay should apply to him as a non-debtor for two reasons. First, “a finding in [the ERISA] case could affect Service Painting’s bankruptcy proceedings.” Second, a ruling in the ERISA case “could preclude the bankruptcy estate from challenging [those] findings.”
The court, relying on Forcine Concrete & Constr. Co. v. Manning Equip. Sales & Serv., 426 B.R. 520 (E.D. Pa. 2010), described two situations in which courts will extend the automatic stay to non-debtors: (1) where extension of the stay would be “essential” to a debtor’s reorganization efforts; and (2) where there is “such identity between the debtor and the third-party” that a judgment against the non-debtor would be a judgment against the debtor. The second situation arises when a debtor would be forced to indemnify the co-defendants if there was an adverse verdict. Neither situation existed in the case.
First, applying In re Uni-Marts, LLC, 404 B.R. 767 (Bankr. D. Del. 2009), the court found that Garavelas was not essential to Service Painting’s reorganization. This situation arises when the “non-debtor must divert ‘critical management resources from the reorganization effort to litigation.’” Garavelas presented no evidence that would show why his defense of the litigation would divert substantial resources.
Second, the court noted that courts in the Third Circuit will extend the automatic stay to non-debtors when the debtor owes them indemnification obligations under either a binding agreement or statutory or common law authority forcing indemnification. The court then cited precedent holding that the indemnitee’s liability typically must arise from his performance of his duties as an employee of the debtor. Thus, in the case at hand, extension of the automatic stay was not warranted. Not only had Garavelas failed to show any indemnification obligations, but he was being sued in his individual capacity for breaching fiduciary duties that he individually owed to the Funds. A judgment against him therefore would not, in effect, be a judgment against Service Painting, and the court declined to extend the automatic stay to Garavelas.
The court also rejected Garavelas’s argument that the court should extend the automatic stay because a judgment against him would be preclusive in Services Paintings’ bankruptcy. The court listed the elements of collateral estoppel: (1) an identity of issues; (2) a final judgment on the merits; (3) a party or privity in the prior adjudication; and (4) a full and fair opportunity to litigate.
Garavelas argued that collateral estoppel would apply against Service Paintings even though it was not a party to the ERISA case because its interests would be “adequately represented” in that proceeding. However, a mere “alignment of interests alone does not warrant application of collateral estoppel to a non-party. The party seeking application of collateral estoppel must show the party in the earlier proceeding must understand he is ‘acting in a representative capacity’ for the non-party.” Initially, the court noted that it could “only speculate as whether a judgment against Garavelas would preclude Service Painting in future litigation,” particularly given that Garavelas failed to offer evidence of any indemnification obligations that might support application of collateral estoppel. Additionally, it explained that a future court likely would not find that Garavelas adequately represented Service Painting in the ERISA case due to his failure to make a “vigorous defense” in that proceeding. Thus, the court concluded that extending the automatic stay would unduly “interfere with creditors’ enforcement of their rights against non-debtor co-defendants.”
Conclusion
Accordingly, and for other reasons stated in its opinion, the court rejected Garavelas’s arguments and declined to extend the automatic stay to protect him from the Funds’ ERISA action.
In re Fed-Mogul Glob., Inc.,
300 F.3d 368 (3d Cir. 2002)
Background
Tens of thousands of individuals (the Plaintiffs) brought personal injury and wrongful death claims in state courts around the United States for asbestos-related injuries from certain “friction products,” such as brake pads (referred to as Friction-Product Claims). The Plaintiffs alleged exposure through the manufacture, repair, installation, and use of brake pads and other products, which caused them to develop mesothelioma and other diseases. Federal-Mogul Global and 156 affiliated entities (the Debtors) were defendants in many of these suits and filed for chapter 11 relief in Delaware on October 1, 2001, resulting in a stay of the state court proceedings against them.
Several other companies who were also defendants in friction-product cases (the Non-Debtor Defendants) attempted to remove many of their cases to the appropriate federal district courts and moved to transfer them to Delaware. They argued that the Delaware District Court had related-to jurisdiction over the Friction-Product Claims against them because they had obtained some of the friction products they used from the Debtors and, therefore, would be entitled to indemnification or contribution from the Debtors.
The District Court granted a provisional transfer of the Friction-Product Claims against the Non-Debtor Defendants, but ultimately denied a permanent transfer and remanded the claims. The District Court held that it lacked subject-matter jurisdiction over the Friction-Product Claims based on the Third Circuit’s opinion in Pacor Inc. v. Higgins (In re Pacor), 743 F.2d 984 (3d Cir. 1984), that “related-to bankruptcy jurisdiction [does] not extend to a dispute between non-debtors unless that dispute, by itself, creates at least the logical possibility that the estate will be affected.” However, a dispute between third parties is, “[a]t best . . . a mere precursor to the potential third party claim for indemnification” against the estate. The District Court therefore concluded that the Friction-Product Claims did not, by themselves, give rise to a possibility that the estate would be effected because (1) any judgment on the claims would not bind the Debtors and (2) the Non-Debtor Defendants’ potential indemnification claims against the Debtors had not yet accrued.
Analysis
The Non-Debtor Defendants appealed the District Court’s ruling. They argued that “the various claims against them could lead to substantial indemnification or contribution claims against Federal-Mogul, which would in turn significantly affect the administration of the bankruptcy estate and the development of an appropriate plan of reorganization.” Thus, focusing on Pacor’s articulation of the test for related-to jurisdiction as “whether the outcome of that proceeding could conceivably have any effect on the estate being administered in bankruptcy,” they emphasized that “the outcome of the Friction Product Claims could conceivably have an effect on Debtors’ estate, because it is ‘conceivable’ that if the Friction Product Plaintiffs succeed in their claims against them, the Friction Product Defendants would seek indemnification and/or contribution from Federal-Mogul.” (Emphasis in original.)
The Non-Debtor Defendants also argued that the Sixth Circuit’s decision in Lindsey v. O’Brien Tanski, Tanzer & Young Health Care Providers of Connecticut (In re Dow Corning), 86 F.3d 482 (6th Cir. 1996), which distinguished Pacor, should control in mass tort situations. The Dow Corning court held that the district court had related-to jurisdiction over thousands of silicone-implant claims against non-debtors because the claims were so numerous that the non-debtors’ contingent indemnification claims against Dow Corning would affect the size of the estate and the length of the case. For the same reasons, the Dow Corning court distinguished Pacor, which involved only one potential indemnification claim: “A single possible claim for indemnification or contribution simply does not represent the same kind of threat to a debtor’s reorganization plan as that posed by the thousands of potential indemnification claims at issue here.”
The Third Circuit upheld the District Court’s decision. The court rejected the defendants’ focus on the word “conceivable” in Pacor because, despite the opinion’s “seemingly broad language,” it rejected the possibility that related-to jurisdiction exists where “the allegedly related lawsuit would [not] affect the bankruptcy proceeding without the intervention of yet another lawsuit.” Thus, related-to jurisdiction did not exist in Federal-Mogul because the Non-Debtor Defendants’ claims against the Debtors “have not yet accrued and would require another lawsuit before they could have an impact on Federal-Mogul’s bankruptcy proceeding.”
The Third Circuit also agreed with the District Court that Dow Corning’s analysis to distinguish Pacor was unpersuasive. The District Court had “regard[ed] with misgiving the proposition that mere numbers of claims should prevail over articulable principles when it comes to defining federal subject matter jurisdiction.” The District Court had also distinguished Dow Corning for the reasons stated in Arnold v. Garlock, Inc., 278 F.3d 426 (5th Cir. 2001):
In [Dow Corning], each of the co-defendants was closely involved in using the same material, originating with the debtor, to make the same, singular product, sold to the same market and incurring substantially similar injuries. This circumstance created a unity of identity between the debtor and the co-defendants not present here, where the co-defendants variously use asbestos for brake friction products, insulation, gaskets, and other uses.
Conclusion
Accordingly, and for other reasons stated in its opinion, the Third Circuit denied the Non-Debtor Defendants’ request to compel transfer of the Friction-Products Claims.
Dunaway v. Purdue Pharms. L.P. (In re Purdue Pharms. L.P.),
619 B.R. 38 (S.D.N.Y. 2020)
Background
In Purdue, the Debtors and various non-debtors, including Purdue’s former or current owners, directors, officers, and other associated entities (collectively, the Related Parties), were subject to more than 2,600 governmental enforcement actions and private lawsuits in state and federal courts (collectively, the Opioid Actions), alleging that Purdue’s manufacture, promotion, and sale of prescription painkillers contributed to the ongoing opioid crisis.
The Debtors therefore sought and obtained a preliminary injunction enjoining all of the Opioid Actions against the Debtors and their Related Parties, including Purdue’s former president and co-chairman, non-debtor Dr. Richard Sackler, whose family has controlled a majority of Purdue’s stock for generations. The Debtors had argued that continuation of the Opioid Actions, and Purdue’s continued defense of the same, “[would] eviscerate the fundamental goals of these bankruptcy cases” and cause the value of their estates to be “rapidly eroded by the staggering direct and indirect costs of [the] litigation.” Indeed, Purdue claimed to owe potential indemnification obligations to its current and former directors and officers, including Dr. Sackler. Further, the claims against the Related Parties were “based on conduct substantially identical to, and inextricably intertwined with, that alleged to have been engaged in by the Debtors.” Thus, the injunction was necessary, inter alia, both to preserve the Debtors’ bankruptcy estates and to prevent the Opioid Actions from resulting in findings of fact or law that would, “at a minimum, create an adverse record against the Debtors.”
Five district attorneys and a private plaintiff (the Appellants) in Dunaway, et al. v. Purdue Pharma L.P. (the Dunaway Action) appealed. In the Dunaway Action, the Appellants sought damages from Purdue and Dr. Sackler, among others. The Appellants asked the District Court to vacate the injunction as to their claims against Dr. Sackler.
Analysis
Jurisdiction
The Appellants argued, inter alia, that the Bankruptcy Court lacked related-to jurisdiction over the Dunaway Action. For several reasons, the District Court rejected the Appellants’ argument.
The District Court explained that “[a] bankruptcy court has ‘related to’ jurisdiction over every case where ‘the action’s outcome might have any conceivable effect on the bankrupt estate.’” Under the conceivable effects test, Second Circuit precedent teaches that “when one tortfeasor files for bankruptcy, any action against their co-tortfeasors for the same conduct falls within the bankruptcy court’s ‘related to’ jurisdiction” because the plaintiff “can only proceed on [its] claims if it establishes that the [debtor’s misconduct] occurred.” Based on the Appellants’ pre-petition complaint against Purdue and Dr. Sackler, the District Court concluded that they could not pursue their allegations against Dr. Sackler without implicating Purdue. These interrelated allegations established related-to jurisdiction even if there was no identity of interests between Purdue and Dr. Sackler. The Bankruptcy Court therefore was correct to exercise jurisdiction over the Dunaway Action.
However, the District Court also agreed with the Debtors’ argument that their alleged indemnification obligations to Dr. Sackler also established related-to jurisdiction. The Appellants asked the District Court to apply the Third Circuit’s test for related-to jurisdiction, which requires an evidentiary record establishing that the third-party dispute may “affect the bankruptcy without the intervention of another lawsuit.” (Emphasis in original.) According to the Appellants, Dr. Sackler’s contingent indemnification claim [was] ‘untested,’” and Purdue’s board had not committed to honoring its indemnification obligations. The Appellants therefore “argued that “without a more rigorous ‘legal standard that requires an evidentiary foundation for invoking a bankruptcy court’s jurisdiction,’ the Debtors’ application of the ‘conceivable effects’ test ‘improperly expands the bankruptcy forum from a court of limited jurisdiction’ to allow it ‘to suspend any dispute in any forum anywhere in the country that conceivably affects a debtor,’” including purely third-party opioid litigation merely involving theories of liability similar to those asserted against Purdue.
The District Court stated that although the Third Circuit’s test “may be a wise policy, it is not the law in the Second Circuit. Courts in this Circuit have embraced neither an elevated evidentiary standard nor proof of ‘automatic liability’ as prerequisites for the bankruptcy court’s exercise of ‘related to’ jurisdiction.” The District Court was therefore satisfied that it was not required to reach the merits of Dr. Sackler’s potential indemnification claim or determine whether he would prevail on that claim to determine whether the Dunaway Action would have a conceivable effect in the Debtors’ bankruptcy cases. Rather, the District Court was satisfied that the Dunaway Action could lead to a fight over the scope of Purdue’s indemnification obligations, and “[t]he mere fact that such a dispute is conceivable is enough to confer jurisdiction on the Bankruptcy Court.” The estate would bear the cost of litigating that dispute, which would satisfy the Second Circuit’s conceivable effects test.
Further, the District Court was unconcerned with the Appellants’ “slippery slope” argument. In particular, the District Court disagreed that there was a risk that opioid litigation involving other non-debtors might become subject to the Bankruptcy Court’s injunction. Critically, litigation not involving Purdue, or its Related Parties would not require “proving facts that would also prove Purdue’s own liability” or result in indemnification or contribution claims against the Debtors. Thus, “this opinion does not amend or extend the outer bound of the conceivable effects test: the jurisdiction of the bankruptcy court remains ‘limited to actions that create contingent obligations against the estate.’”
Injunction Pursuant to Section 105(a)
The District Court also addressed the parties’ arguments concerning whether the Bankruptcy Court abused its discretion in ordering the preliminary injunction. Much of the dispute focused on whether there was a likelihood of a successful reorganization. However, the District Court also focused on whether the preliminary injunction was necessary to prevent irreparable harm to the estate and whether the public interest weighed in favor of issuing the injunction.
The District Court answered both questions in the affirmative. First, it agreed that the estate would suffer irreparable harm because, inter alia, “the Dunaway Action, if allowed to proceed against Dr. Sackler alone, ‘would embarrass, burden, delay or otherwise impede the debtor’s estate and reorganization prospects.’” Indeed, “[i]t would certainly embarrass Purdue for one of its largest shareholders and former leaders to be found culpable for the opioid epidemic.” Second, although the District Court agreed with the Bankruptcy Court that there was a public interest in transparency that would be served by allowing the Dunaway Action to proceed, thereby requiring Dr. Sackler to “answer for his personal role in the opioid epidemic in Tennessee.” However, both courts also concluded that the balance of hardships favored the Debtors, because the injunction “does not destroy Appellants’ interest in transparency. It does not immunize Dr. Sackler against personal liability, and it does not protect him from having to disclose details about his personal wealth.” Rather, “there will be transparency as to what happened here upon confirmation of a plan and thereafter.” Thus, “[t]he balance of the hardships and the public interest favor leaving the injunction in place.”
Conclusion
Accordingly, and for other reasons stated in its opinion, the District Court affirmed the Bankruptcy Court’s orders entering (and extending) the preliminary injunction.
11 U.S.C. § 362
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of–
(1) The commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;
. . . .
11 U.S.C. § 105
(a) The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.
Authority Summaries for Question 2
Spyglass Media Grp., LLC v. Bruce Cohen Prods. (In re Weinstein Co. Holdings, LLC),
997 F.3d 497 (3d Cir. 2021)
Background
In September 2011, Bruce Cohen and his production company entered into an agreement (the Cohen Agreement) with SLP Films, Inc. (SLP), a special purpose entity formed by The Weinstein Company (TWC) to make the film Silver Linings Playbook. The Cohen Agreement was structured as a work-made-for-hire contract where Cohen, himself, owned none of the intellectual property in the film. In exchange for the production, SLP agreed to pay Cohen $250,000 in fixed compensation, as well as contingent future compensation based on the film’s net profits. The film was a success, and soon after its release, TWC, through the dissolution of the other owning entity, ended up with full rights to the film.
Nonetheless, in March 2018, after the Harvey Weinstein scandal unfolded, TWC filed for chapter 11 relief and sought the Bankruptcy Court’s approval of a sale of the business to Spyglass Media Group, LLC under section 363 of the Bankruptcy Code. The sale closed in July 2018, but provided Spyglass with a four-month cushion (until November 2018) to designate which of TWC’s executory contracts it wanted to assume as part of the sale. Spyglass believed the Cohen Agreement was not an executory contract at all and filed a declaratory judgment action against Cohen seeking a determination that the Cohen Agreement was not executory and thus already part of the sale to Spyglass. In November 2018, additional writers, producers, and actors with similar work-made-for-hire contracts “hitched their wagon to the Cohen dispute and argued that their contracts are also executory.” If the work-made-for-hire contracts were executory, Spyglass would have been responsible for millions of dollars in contingent compensation to each work-made-for-hire contract formed with TWC.
In January 2019, the Bankruptcy Court issued a bench ruling concluding that the Cohen Agreement was not an executory contract and thus could be sold to Spyglass under section 363. The District Court affirmed the Bankruptcy Court’s decision, and Cohen appealed.
Analysis
Before exploring the parties’ arguments, the court discussed the general premises underlying the Bankruptcy Code’s provisions governing the assumption and rejection and executory contracts. On one extreme, “a contract where the debtor fully performed all material obligations, but the nonbankrupt counterparty has not . . . can be viewed as just an asset of the estate with no liability.” Such a contract should not be treated as executory because doing so “risks inadvertent rejection” of an asset. On the other extreme, “where the counterparty performed but the debtor has not, the contract . . . is only a liability for the estate.” Such a contract should not be treated as executory because doing so “risks inadvertent assumption” of a liability that should instead be treated as a mere unsecured claim. Only “where there can be uncertainty if the contract is a net asset or liability for the debtor” should it be treated as executory and therefore subject to assumption or rejection and the requirement to cure existing defaults before assumption. That requirement, the court noted, “is motivated by fairness to the nonbankrupt counterparty, as assuming the contract essentially provides a ‘means whereby a debtor can force others to continue to do business with it when the bankruptcy filing might otherwise make them reluctant to do so.’”
Next, the court discussed the specific legal principles governing executory contracts. It cited the Countryman Test, pursuant to which a contract is executory if, under applicable state law, each party to the contract has at least one material unperformed obligation as of the petition date. New York law governed the Cohen Agreement, and therefore New York law governed whether both TWC and Cohen each owed at least one obligation thereunder that would give rise to a material breach if not performed. The court explained that New York law defines as a material breach the failure to do something that is so fundamental to the contract that such failure defeats the essential purpose of the contract, but that it also applies the “substantial performance” rule, which provides that “[i]f the party in default has substantially performed, the other party’s performance is not excused.” The Third Circuit characterized these rules as “two sides of the same coin,” because “if it is determined that a breach is material, or goes to the root or essence of the contract, it follows that substantial performance has not been rendered.”
Spyglass’s primary argument that the Cohen Agreement was not an executory contract capable of being assumed and assigned was that the “root” purpose of the contract had been substantially performed. Cohen made two key arguments in response. First, he argued that he owed outstanding material obligations that would give rise to a material breach if not performed. Second, he argued that where parties have contracted around the substantial performance rule by agreeing that an obligation is material, a court should not substitute its own judgment.[3]
Despite acknowledging that Cohen’s arguments were “forceful,” the court ultimately affirmed the Bankruptcy Court’s and District Court’s decisions and held that the Cohen Agreement was not an executory contract.
First, in determining whether there were outstanding material obligations on both sides of the Cohen Agreement, the court held that TWC’s obligation to pay contingent compensation to Cohen was clearly material. However, the court determined that Cohen’s remaining obligations were not material because they did not go to the “root of the contract” or “defeat the purpose of the entire transaction” if breached. Cohen’s only remaining obligations were to refrain from seeking injunctive relief about the exploitation of the movie and to indemnify TWC against third-party claims arising from the breach of his representations and warranties (most of which had surpassed the statute of limitations). Thus, only TWC owed material unperformed obligations under the Cohen Agreement.
Second, in looking at whether the Cohen Agreement was executory on its face, the court found that the parties here did not clearly and unambiguously avoid the substantial performance rule for evaluating executory contracts. The court stated that the language included in the Cohen Agreement was merely a condition—that TWC must pay the contingent compensation if Cohen is “not otherwise in breach or default”—which, unlike a duty, cannot render a contract executory for purposes of section 365. Further, it noted that all of Cohen’s citations involved courts deferring to parties’ agreements concerning the materiality of specific contract terms that were expressed through remedies or termination provisions. This was a “meaningful distinction,” the court stated, because “[w]hen parties say that breach of a provision would result in termination or rescission of the contract, they make clear that the provision is material.” In contrast, “covenants address the parties’ obligations . . . and typically are not a natural place to look when determining which of those obligations the parties consider to be material.” (Emphasis in original.)
Finally, the court also explained that if it accepted Cohen’s argument, then the Cohen Agreement would be executory forever, no matter how much of the contract had been performed. This, the court stated, “would contravene the protections created for debtors by the bankruptcy code.” Thus, the court concluded, “the Bankruptcy Code views the Cohen Agreement as a non-executory contract that is in essence a liability for the Debtors that can be sold to Spyglass . . . without the need to cure existing defaults.”
Conclusion
As such, the Third Circuit concluded that any contingent compensation owed to Cohen under the Cohen Agreement before its sale to Spyglass could only be asserted as an unsecured claim.
Gen. DataComm Indus., Inc. v. Arcara (In re Gen. DataComm Indus., Inc.),
407 F.3d 616 (3d Cir. 2005)
Background
In 1997, General DataComm Industries Inc. entered into a benefit agreement with certain long-term senior executives (the Benefit Plan), under which DataComm would fund two forms of insurance benefits for these executives: (1) long-term care insurance coverage for the lifetime of each eligible executive and his spouse; and (2) upon retirement, for each eligible executive and his spouse, a lifetime continuation of health insurance benefits. The Benefit Plan listed certain actions which, if taken by an eligible executive, would lead to the loss of all benefits under the Benefit Plan, including violating any confidentiality agreement, disclosing any proprietary information, refusing to cooperate with DataComm in litigation, directly or indirectly becoming employed by a competitor, or bringing suit against DataComm (the Restrictive Covenants). Four of the eligible executives (the Executives) brought this suit.
In November 2001, DataComm filed for relief under chapter 11 of the Bankruptcy Code. Soon after, DataComm advised the Executives—all of whom were at retirement age, but had yet to retire—that they would be terminated on November 30, 2001, and that the Benefit Plan would be terminated on that same date. The day before their termination, DataComm moved to reject the Benefit Plan. The Executives objected, claiming that the Benefit Plan qualified for treatment under section 1114 of the Bankruptcy Code as insurance benefits to retired employees because their termination was a “forced retirement.” The Bankruptcy Court agreed and denied DataComm’s motion to reject the Benefit Plan. The District Court affirmed.
Analysis
The court was confronted with two questions: (1) whether the Executives constituted “retired employees” for the purposes of invoking the protections of section 1114, and (2) if so, whether the Benefits Plan could be rejected pursuant to section 365.
Addressing the first question, DataComm argued that section 1114 didn’t apply because the Executives had not retired at the time of the motion to reject the Benefit Plan. The Third Circuit rejected this argument on fairness grounds, stating that accepting the argument when DataComm had fired the Executives the day after filing its motion would “contravene[] basic norms of fairness and undermines the purposes of [section] 1114, which ‘was enacted to protect the interests of retirees of [c]hapter 11 debtors.’” The Third Circuit also agreed with the District Court that DataComm should not be permitted to escape its obligations under the Benefit Plan by arguing that the Executives were terminated without cause rather than retired, given that “the intent of both DataComm and the [Executives] was that the [Executives] would receive the retirement benefits of the [Benefit] Plan unless they were terminated for cause.” (Emphasis added.) In reaching this conclusion, the court relied on a citation to the “prevention doctrine,” which stated that “[w]here a promisor prevents, hinders, or renders impossible the occurrence of a condition precedent to his or her promise to perform, or to the performance of a return promise, the promisor is not relieved of the obligation to perform.” For these and other reasons, the court held that section 1114, not section 365, controlled.
In a concurring opinion, Judge Pollak disagreed with the court’s reliance on the prevention doctrine and stated that the prevention doctrine can do no more than return the parties to the situation that existed prior to the Executives’ dismissal. Because the Executives had not yet retired when DataComm sought to terminate the agreement, the prevention doctrine should not have changed the outcome even if it applied. It would merely reinstate the Executives as employees who had not yet gained the protections of section 1114.
Addressing the second question, the court was satisfied that the Benefit Plan was executory. The court recited the definition of an executory contract as “a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.” However, the court concluded that while state law defines what constitutes a material breach, the parties had agreed that the Executives’ Restrictive Covenants were material obligations through a provision allowing DataComm to terminate the Executives’ benefits if they breached the Restrictive Covenants. The court therefore declined to engage in a materiality analysis, deferring to the parties’ agreement. However, because the Executives were protected under section 1114, DataComm could not reject the Benefit Plan even if it were executory.
Judge Pollak again disagreed, concluding that the plan was not executory. Rather than deferring to the parties’ agreement that the Restrictive Covenants were material, he applied Delaware state law, under which the materiality test set forth in the Restatement (Second) of Contracts controls.[4] The “defining feature” of the Restatement’s five-factor test is “the connection between materiality and consideration,” such that “one party’s obligation [will be deemed] material where it serves as consideration for the other party’s promised performance.”[5] Thus, stating that “a party’s obligation to perform or forbear will be material if it functioned as consideration, or as the reason inducing the other party’s entry into the contract,” Judge Pollak concluded that the Restrictive Covenants were not material. Indeed, the Executives’ “forbearance is not what motivate[d] or compensate[d] DataComm’s performance. Instead, the [Benefit] Plan memorialized a promise by DataComm to furnish its long-standing executives with certain benefits.” He also relied on Third Circuit precedent holding that “while ‘a contracting party’s failure to fulfill a condition excuses performance by the other party whose performance is so conditioned, it is not, without an independent promise to perform the condition, a breach of contract subjecting the nonfulfilling party to liability for damages.’” The Restrictive Covenants were conditions, Judge Pollak reasoned, not duties, because while breach would excuse DataComm’s performance, it would not subject the Executives to liability for damages.
Judge Pollak therefore joined in the court’s judgment—but not its reasoning—that DataComm could not reject the Benefit Plan.
Conclusion
The Third Circuit affirmed both the Bankruptcy Court and District Courts decisions—even though the Benefit Plan was an executory contract, the Executives were “retired employees” within the meaning of section 1114. Thus, the Benefit Plan could not be rejected.
In re Sea Oaks Country Club, LLC,
Ch. 11 Case No. 20-17228, 2020 WL 6588412 (Bankr. D.N.J. 2020)
Background
Sea Oaks Country Club, LLC (the Country Club) and Sea Oaks Golf Club, LLC (the Golf Club) filed for chapter 11 relief on June 3, 2020 with the ultimate goal of seeking the Bankruptcy Court’s approval of a section 363 sale to Atlantic Homes, Inc. Atlantic Homes was a 49 percent owner of both the Country Club and the Golf Club and held a claim against the Debtors in the amount of $10,440,342.50.
Sea Oaks Country Club, L.L.P. (the LLP) was a predecessor of the Debtors. The LLP had constructed, owned, and operated the Golf Club and the Country Club. When first opened, the LLP advertised lifetime golf memberships (the Lifetime Memberships), which offered benefits such as no greens fees, preferential tee times, complimentary golf cart use, discounts on merchandise, and other amenities. In addition to these benefits, the Lifetime Membership certificates stated that they were “irrevocable and shall continue in perpetuity.” To obtain a Lifetime Membership, the members would pay a lump sum of $50,000 or $60,000.
After the Debtors filed bankruptcy, they filed a motion for an order (1) approving the sale of their assets free and clear of liens, claims, and encumbrances; (2) authorizing the assumption and assignment of certain executory agreements and leases; and (3) rejecting other executory agreements and leases and all membership agreements. The third form of relief requested was the subject of the relevant part of this opinion.
Certain parties (the Lifetime Members) filed an objection to any sale that would allow the Debtors to reject their Lifetime Memberships. They primarily argued that (1) they had fully performed their obligations with respect to the Lifetime Memberships when they made their upfront, lump-sum payment and (2) because the Lifetime Memberships were irrevocable, they were not executory contracts and could not be rejected under section 365 of the Bankruptcy Code.
In response, the Debtors argued that the Lifetime Memberships were executory contracts subject to rejection under section 365 because the Lifetime Members had continuing obligations to keep their accounts current and act in accordance with the rules and regulations of the Country Club and the Golf Club.
Analysis
The court explained that the Third Circuit defines an executory contract as “a contract under which the obligation of both the bankrupt and the other party to the contract are so far underperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.” Further, the court explained that unless both parties had unperformed obligations that would give rise to a material breach if not performed (as determined pursuant to applicable state law), a contract is not executory.
Based on this definition, the court found that both the Debtors and the Lifetime Members had unperformed obligations. On the one hand, the Debtors still were obligated to maintain and provide access to the golf course and its amenities. On the other hand, the Lifetime Members still were required to settle their accounts for any purchases of merchandise or food, they were prohibited from defacing club property, and they were obligated to comply with scheduled tee times and rules of play. However, the main question was whether these obligations were material.
The Lifetime Members relied on a New Jersey Supreme Court case, Ross Systems v. Linden Dari-Delite, 173 A.2d 258 (1969), pursuant to which, they argued, a breach is only material if it goes to the essences of the contract and allows the non-breaching party to actually terminate the contract. The court rejected this interpretation of Ross Systems, and instead clarified that in addition to determining whether the breach goes to the essence of the contract, to be material, the breach must also allow the non-breaching party to treat the contract as terminated and refuse to render continued performance.
As the Lifetime Members’ obligations “[c]ertainly” went to the essence of the contract, the court reasoned that while the Debtors might not be able to terminate the Lifetime Memberships, they must have had some redress for a material breach by a Lifetime Member. That redress included terminating the Debtors’ own performance obligations, which established that the Lifetime Members’ obligations were material.
Conclusion
The court held that because both parties had mutual unperformed obligations that were material under New Jersey state law, the Lifetime Memberships were executory contracts that could be rejected by the Debtors.
11 U.S.C. § 365
(a) Except as provided in sections 765 and 66 of this title and in subsections (b), (c), and (d) of this section, the trustee, subject to the court’s approval, may assume or reject any executory contract or unexpired lease of the debtor.
(b) (1) If there has been a default in an executory contract or unexpired lease of the debtor, the trustee may not assume such contract or lease unless, at the time of assumption of such contract or lease, the trustee–
(A) cures, or provides adequate assurance that the trustee will promptly cure, such default other than a default that is a breach of a provision relating to the satisfaction of any provision (other than a penalty rate or penalty provision) relating to a default arising from any failure to perform nonmonetary obligations under an unexpired lease of real property, if it is impossible for the trustee to cure such default by performing nonmonetary acts at and after the time of assumption, except that if such default arises from a failure to operate in accordance with a nonresidential real property lease, then such default shall be cured by performance at and after the time of assumption in accordance with such lease, and pecuniary losses resulting from such default shall be compensated in accordance with the provisions of this paragraph;
(B) compensates, or provides adequate assurance that the trustee will promptly compensate, a party other than the debtor to such contract or lease, for any actual pecuniary loss to such party resulting from such default; and
(C) provides adequate assurance of future performance under such contract or lease.
11 U.S.C. § 1114
(a) For purposes of this section, the term “retiree benefits” means payments to any entity or person for the purpose of providing or reimbursing payments for retired employees and their spouses and dependents, for medical, surgical, or hospital care benefits, or benefits in the event of sickness, accident, disability, or death under any plan, fund, or program (through the purchase of insurance or otherwise) maintained or established in whole or in part by the debtor prior to filing a petition commencing a case under this title.
. . . .
(e) (1) Notwithstanding any other provision of this title, the debtor in possession, or the trustee if one has been appointed under the provisions of this chapter (hereinafter in this section “trustee” shall include a debtor in possession), shall timely pay and shall not modify any retiree benefits, except that–
(A) the court, on motion of the trustee or authorized representative, and after notice and a hearing, may order modification of such payments, pursuant to the provisions of subsections (g) and (h) of this section, or
(B) the trustee and the authorized representative of the recipients of those benefits may agree to modification of such payments, after which such benefits as modified shall continue to be paid by the trustee,
after which such benefits as modified shall continue to be paid by the trustee.
Authority Summaries for Question 3
Stewart v. Holland Acquisitions, Inc.,
Civ. No. 15-01094, 2021 WL 1037617 (W.D. Pa. Mar. 18, 2021)
Background
On February 4, 2021, Holland Acquisitions, Inc., filed a chapter 7 bankruptcy petition. Shortly thereafter, it filed a suggestion of bankruptcy in a pre-petition Fair Labor Standards Act (FLSA) action that had been filed against it by the Department of Labor. The Department had accused the Debtor of repeatedly and deliberately violating the FLSA by failing to fairly compensate its employees. Thus, it sought not only to recover back wages and liquidated damages for the Debtor’s injured employees, but also “an equitable judgment . . . permanently enjoining and restraining any future FLSA violations by [the Debtor].”
The issue before the court was whether the Department’s action was subject to the automatic stay, or whether the police powers exception applied under section 362(b)(4). The Debtor argued that the police powers exception did not apply to the Department’s action because the Department sought relief protecting the rights of private individuals. In contrast, the Department argued that its action served to “promote public policy by enforcing a remedial statute” and that the relief it sought related “principally to the government’s public policy interest in the general welfare of the employees.” Therefore, it asserted, the police powers exception did apply.
Analysis
Initially, the court noted that the Third Circuit applies two “overlapping and complementary tests” to determine “whether the [Department’s] action advances [its] ‘police or regulatory power’ such that the exception to the automatic stay would be triggered.” The first test is the “pecuniary purpose test,” focusing on “whether the government primarily seeks to protect a pecuniary governmental interest in the debtor’s property, as opposed to protecting the public safety and health.” The second test is the “public policy test,” focusing on “whether the government is effecting public policy rather than adjudicating private rights.”
Agreeing with the Department, the court concluded that to stay an FLSA action for back wages and liquidated damages, “hand in hand with prospective injunctive relief,” would “substantially impair the core remedial purposes of the FLSA.” Indeed, based on section 362(b)(4)’s legislative history, actions to fix damages for the violation of police or regulatory laws, and for issuance and enforcement of an injunction, were intended to be excepted from the automatic stay. Further, the FLSA was “exactly the type of remedial statute intended to advance public safety and welfare as well as promote a public policy that goes to concerns beyond only the payment of wages earned and payable by statute to one or more discrete individuals.”
In rejecting the Debtor’s position—and its citation to the Sixth Circuit’s decision in an analogous case, Chao v. Hosp. Staffing Servs., Inc., 270 F.3d 374 (6th Cir. 2001)—the court admitted that “it is true that successful litigation by the [Department] will often result in the award of backpay and liquidated damages to workers who had been deprived of legally mandated compensation (and that could be one outcome here).” However:
[A] key purpose of even those lawsuits is to bring a culpable employer into compliance with the FLSA going forward. The award of what may turn out to be sizeable money damages is intended to foster that result. And more than that, the possibility of prospective injunctions and the award of ancillary backpay and liquidated damages serves to deter others from failing to fulfill their wage-payment duties under the FLSA, and to signal to the marketplace the critical importance of employers’ compliance with that vital federal statute.
(Emphasis added.) Thus, to characterize the Department’s lawsuit as one seeking only to “ascertain the rights of a private individual and obtain judgment for that individual’s benefit” would “inaccurately minimize[] both the litigation role of the [Department] under the FLSA and the purposes of such litigation.” The court instead concluded that “while there would be a monetary benefit to workers deprived of earned compensation if the [Department] prevails in this case, the principal role of the [Department] in maintaining this lawsuit is to vindicate the public policy central to the FLSA.”
Conclusion
The court therefore held that the Department’s action was excepted from the automatic stay and allowed it to proceed, expressly disagreeing with the Sixth Circuit’s decision and reasoning in Chao.
Chao v. Hosp. Staffing Servs., Inc.,
270 F.3d 374 (6th Cir. 2001)
Background
Hospital Staffing Services, Inc. (HSSI) was a company in the business of providing home health care and other health-related services to patients primarily in Tennessee and New England. While HSSI relied on Medicare and insurance, the majority of HSSI’s revenue came from a secured revolving loan agreement with Capital Healthcare Financing (CHF). In March 1998, HSSI filed a petition for chapter 11 reorganization in the Bankruptcy Court for the Southern District of Florida. HSSI was able to stay afloat for almost a year during the reorganization due to a court-approved $8,000,000 loan from CHF.
Despite this loan, HSSI failed to reorganize and converted its bankruptcy to a chapter 7 liquidation. A chapter 7 trustee (the Trustee) was appointed. The Department of Labor subsequently filed an action under the Fair Labor Standards Act (the FLSA) in the United States District Court for the Western District of Tennessee (the District Court). The Department contended that certain of the Debtor’s records were “hot goods,” i.e., that they had been produced in violation of the FLSA, because the Debtor did not pay approximately 600 employees during its last weeks in operation. The Department sought an injunction barring the Trustee from transporting the records across state lines and obtained a preliminary injunction from the District Court directing him to deposit the amount necessary to clear the hot goods designation.
The Trustee needed the Debtor’s records to bill its patients and seek Medicare reimbursements. Accordingly, he appealed to the Sixth Circuit, disputing the District Court’s jurisdiction over the Department’s FLSA action and the allegedly hot goods.[6] In particular, the Trustee disagreed with the District Court’s conclusion that the police powers exception to the automatic stay applied to the action under section 362(b)(4).
Analysis
The Trustee presented two arguments. First, if the Department obtained a money judgment, it would improperly elevate the unpaid workers’ claims from administrative expenses to super-priority claims. Second, the Trustee argued that the Department’s suit would disrupt the Bankruptcy Code’s equitable distribution scheme and interfere with the Bankruptcy Court’s jurisdiction. The Department maintained, inter alia, that the District Court was correct to exercise jurisdiction over its FLSA action based on the police powers exception to the automatic stay.
The court agreed with the Trustee’s jurisdictional argument. While the automatic stay protects bankruptcy court jurisdiction subject to the police powers exception, among others, the Department’s action did not pass the public policy test as required under section 362(b)(4). Instead, the court concluded that the Department’s action primarily benefited private individuals.
The court’s reasoning was influenced by caselaw recognizing that the FLSA “reflects Congress’[s] desire to eliminate the competitive advantage enjoyed by goods produced under substandard conditions” and protects interstate commerce from being made “the instrument of competition in the distribution of goods produced under substandard labor conditions, which competition is injurious to the commerce.” Thus, FLSA actions brought “to protect legitimate businesses from unfair competition and to enforce the federal law regarding minimum wage” will fall within the police powers exception.
However, “[t]he existence of the public policy test naturally presumes that some suits by governmental units, even though they would effectuate certain declared public policies, will nevertheless be regarded as largely in furtherance of private interests.” Therefore, “when the action incidentally serves public interests but more substantially adjudicates private rights, courts should regard the suit as outside the police power exception, particularly when a successful suit would result in a pecuniary advantage to certain private parties vis-a-vis other creditors of the estate, contrary to the Bankruptcy Code’s priorities.” Even though such an action can “punish wrongdoers and thereby provide a general deterrent to unfair labor practices,” it may still not pass the public policy test if it “serves little public purpose other than a general interest in seeing laws enforced.”
The court concluded that the Department’s hot goods action against the Trustee primarily benefited the Debtor’s unpaid workers. Indeed, the “significant public interest in protecting other businesses from unfair competition [was] not present because the ‘goods’ [were] merely records relating to services already rendered by employees.” The goods would not be sold in interstate commerce, therefore the Department’s suit would not prevent unfair competition or protect “other workers in the economy” whose livelihoods would be “threatened by the introduction of [such] goods into the national economy.” Rather, the action was “merely a vehicle to enforce the private rights of the employees to the minimum portion of their wages Congress guaranteed.”
Conclusion
Accordingly, the court held that the police powers exception did not apply. The Bankruptcy Court therefore had exclusive jurisdiction and the District Court should have dismissed the Department’s FLSA action. Notably, however, a dissenting opinion suggested that the majority’s discussion improperly narrowed the scope of the public policy test.
11 U.S.C. § 362
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—
(1) The commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;
. . . .
(b) The filing of a petition under section 301, 302, or 303 of this title, or of an application under section 5(a)(3) of the Securities Investor Protection Act of 1970, does not operate as a stay—
. . .
(4) under paragraph (1), (2), (3), or (6) of subsection (a) of this section, of the commencement or continuation of an action or proceeding by a governmental unit or any organization exercising authority under the Convention on the Prohibition of the Development, Production, Stockpiling and Use of Chemical Weapons and on Their Destruction, opened for signature on January 13, 1993, to enforce such governmental unit’s or organization’s police and regulatory power, including the enforcement of a judgment other than a money judgment, obtained in an action or proceeding by the governmental unit to enforce such governmental unit’s or organization’s police or regulatory power;
. . . .
Authority Summaries for Question 4
Cal. Coast Univ. v. Aleckna (In re Aleckna),
13 F.4th 337 (3d Cir. 2021)
Background
The Debtor, a former student at California Coast University, filed for chapter 13 relief in 2012 and subsequently asked for a copy of her transcript from the University. The University provided her with an incomplete copy that did not list her graduation date, explaining that because she still owed approximately $6,300 in unpaid tuition, she was not considered to have graduated. The University then filed a non-dischargeability complaint against the Debtor for the tuition.
The Debtor responded with a counterclaim for damages under section 362(k) of the Bankruptcy Code, asserting that the University had willfully violated the automatic stay of acts to collect pre-petition debts in violation of section 362(a)(6) by refusing to provide her with a complete transcript. The University eventually withdrew the non-dischargeability action with prejudice, but still refused to provide the Debtor with a complete transcript.
The Bankruptcy Court agreed with the Debtor. Analogizing to providing an unsigned letter of reference, the Bankruptcy Court concluded that providing the Debtor with an incomplete transcript was tantamount to providing no transcript at all. Accordingly, the Bankruptcy Court found that the University had willfully violated the automatic stay and awarded the Debtor nominal damages and substantial attorneys’ fees.
The University appealed, asserting a defense to willful stay violations under the Third Circuit’s decision in University Medical Center v. Sullivan (In re University Medical Center), 973 F.2d 1065 (3d Cir. 1992). University Medical held that a party does not “willfully” violate the automatic stay if “the law governing the alleged violation was ‘sufficiently uncertain.’” The University argued that existing case law was ambiguous as to whether it would have violated the automatic stay not to provide the Debtor with a complete copy of her transcript. The District Court rejected the University’s argument because it failed to cite any persuasive authorities holding that its conduct would not have violated the automatic stay, and affirmed the Bankruptcy Court’s order.
The University then appealed to the Third Circuit, conceding that it violated the automatic stay, but maintaining, inter alia, that University Medical provided it with a defense.
Analysis
The Third Circuit affirmed. Initially, it engaged in a thorough analysis to confirm that University Medical was not legislatively overruled when the relevant provision of section 362 to provide that “an individual who commits a willful violation is liable for damages and attorneys’ fees unless ‘such violation is based on an action taken by an entity in the good faith belief’ that the stay had terminated due to the debtor’s failure to file a timely notice of intention.”
The Third Circuit then explained why it agreed with the District Court that University Medical did not shield the University from liability. The University had failed to establish a defense under University Medical because it relied on the purported absence of any authorities holding that its conduct violated the automatic stay, rather than citing authorities affirmatively establishing that its conduct did not violate the automatic stay. Indeed, “a lack of case law to the contrary does not render the law sufficiently unsettled under University Medical.” Instead, to establish a defense under University Medical, “[a] defendant must point to authority that reasonably supports its belief that its actions were in accordance with the stay.”
Conclusion
Accordingly, the Third Circuit rejected the University’s defense under University Medical, among other arguments, and affirmed the District Court’s order.
City of Chicago v. Fulton,
141 S. Ct. 585 (2021)
Four Debtors whose vehicles had been impounded by the City of Chicago pre-petition for unpaid fines asserted that the City’s post-petition refusal to return their vehicles violated the automatic stay of acts to obtain possession of or exercise control over property of the estate under section 362(a)(3). The Bankruptcy Court and Seventh Circuit ruled in favor of the Debtors, finding that merely continuing pre-petition possession or control of property of the estate violated subsection (a)(3).
Interpreting the plain language of subsection (a)(3), the Supreme Court reversed on appeal. The Supreme Court held that “the most natural reading” of the words “stay,” “act,” and “exercise control,” as used in subsection (a)(3), prohibited affirmative acts that would disturb the status quo as of the petition date. Indeed, “the language of § 362(a)(3) implies that something more than merely retaining power is required to violate the disputed provision.”
However, the Supreme Court expressly limited its holding to subsection (a)(3), stating that it could not “definitively rule out” the Debtors’ interpretation of the words used therein and admitting that, “as [the Debtors] point out, omissions can qualify as ‘acts’ in certain contexts.” Thus, in a concurring opinion, Justice Sotomayor wrote separately to emphasize that “the Court has not decided whether and when § 362(a)’s other provisions may require a creditor to return a debtor’s property,” citing to a Seventh Circuit decision holding that a university’s refusal to provide a transcript to a debtor violated the automatic stay of acts to collect pre-petition debts under subsection (a)(6).
Margavitch v. Southlake Holdings, LLC (In re Margavitch),
Adv. No. 20-00014, 2021 WL 4597760 (M.D. Pa. Oct. 6, 2021)
Background
On December 17, 2019, Anthony Margavitch, Jr., filed for bankruptcy under chapter 13. Before filing for bankruptcy, Margavitch had been sued by Southlake Holdings, LLC, through its loan servicing agent Auburn Loan Servicing, Inc. (collectively, the “Defendants”). Southlake had obtained a judgment and filed a praecipe for writ of execution against Penn East Federal Credit Union as garnishee. Margavitch owned funds in two Penn East accounts that were subject to attachment as of the petition date. Through their respective counsel, Margavitch asked the Defendants to discontinue the attachment because it was a violation of the automatic stay. The Defendants disagreed and refused to withdraw the attachment.
On February 10, 2020, Margavitch commenced an adversary proceeding alleging, inter alia, that the Defendants violated subsections (a)(1) through (a)(6) of the automatic stay.[7] The parties filed cross-motion for summary judgment and, at the court’s request, supplemental briefings following the Supreme Court’s decision in City of Chicago v. Fulton, 141 S. Ct. 585 (2021). Fulton had held that an affirmative act to change the status quo was required to violate the automatic stay of acts to obtain possession of or exercise control over property of the estate under section 362(a)(3), rejecting the position that merely continuing pre-petition possession or control was a violation. Margavitch asserted that Fulton was inapplicable, arguing that its holding was limited to cases involving possession of tangible property, whereas the Defendants did not have physical possession of any of the Debtor’s property. The Defendants argued that they took no affirmative actions after the petition date, and that even though Fulton was limited to section 362(a)(3), it should be applied to the other subsections of the automatic stay.
Analysis
The court, applying Fulton, found that the Defendants did not violate the automatic stay by refusing to withdraw the valid state court pre-petition attachment on the Debtor’s accounts. The court reasoned that the Defendants’ only affirmative acts occurred pre-petition, whereas their post-petition acts were better characterized as inactions to preserve the status quo as of the petition date. Thus, rejecting the Debtor’s attempt to distinguish Fulton because the Defendants did not have physical possession of the Debtor’s funds, the court held that the Defendants did not violate subsection (a)(3) of the automatic stay by refusing to withdraw the attachment.
The court also held that Fulton should be applied to subsections (a)(4), (5), and (6) of the automatic stay because they all begin with the phrase “any act to . . . .” Thus, because the Defendants did not take any affirmative act post-petition, they did not violate the automatic stay of acts to create, perfect, or enforce a lien or collect a pre-petition debt.
Next, the court held that the Defendants did not violate subsection (a)(1), which stays the commencement or continuation of judicial, administrative, or other actions or proceedings against Debtors. Citing In re Iskric, 496 B.R. 335 (Bankr. M.D. Pa. 2013), the Debtor argued that the Defendants violated subsection (a)(1) because they did not affirmatively act to avoid violating the automatic stay. Iskric held that a creditor violated the automatic stay by allowing the continuation of a proceeding that ultimately resulted in a bench warrant and incarceration of the Debtor. The court distinguished Iskric because it was “an example of a factual scenario where if a creditor has put a process into effect that, without intervention, causes a change in the status quo as to property of the estate or the Debtor, then a creditor must act to avoid that change of the proceeding in that case changed the status quo.” In contrast, continuation of the attachment in Margavitch did not change the status quo and the Defendants did not continue to pursue the garnishment process.
Finally, the court held that the Defendants did not violate subsection (a)(2), which stays acts to enforce a pre-petition judgment. The court reasoned that the mere passive maintenance of the pre-petition attachment could not be construed as an affirmative act to enforce a judgment post-petition and did not change the status quo.
Conclusion
Finding that Fulton controlled as to subsection (a)(3) and should be extended to the other subsections of the automatic stay, the court held that the Defendants did not commit the alleged stay violations because they did not take any affirmative post-petition acts to change the status quo.
Cordova v. City of Chicago (In re Cordova),
Ch. 13 Case No. 19-06255, Adv. No. 19-00684,
2021 WL 5774400 (Bankr. N.D. Ill. Dec. 6, 2021)
Background
Between 2016 and 2019, several residents (the Plaintiffs) of the City of Chicago had their vehicles impounded by the City for unpaid fines. After the vehicles were impounded, each of the Plaintiffs filed for bankruptcy under chapter 13. The Plaintiffs requested release of the impounded vehicles, but the City refused unless the Plaintiffs paid upfront fees and treated its claims as fully secured in their respective bankruptcy cases. The Plaintiffs subsequently filed a putative class action complaint against the City asserting, inter alia, violations of the automatic stay under subsections (a)(4), (a)(6), and (a)(7).[8]
The City filed a motion to dismiss, arguing, inter alia, that Fulton’s affirmative act requirement should be extended to the other subsections of the automatic stay. The Plaintiffs argued that Fulton only applies to section 362(a)(3) and that they sufficiently alleged claims under the remaining subsections.
Analysis
The court declined to extend Fulton to the other subsections of the automatic stay because “(a) Fulton is limited by its own terms to section 362(a)(3) and thus retention of the vehicles may still be a stay violation; (b) [t]he City may have committed other acts in violation of the automatic stay; and (c) [t]he City’s interpretation leaves debtors with virtually no immediate remedy . . . at all.” The court relied on Justice Sotomayor’s concurring opinion in Fulton that there were clear limitations to the Supreme Court’s ruling and that only section 362(a)(3) contained the phrase “to exercise control.” The court then cited the majority ruling in Fulton, which recognized that omissions or inactions combined with other facts could qualify as acts under the other subsections of the automatic stay.
Thus, the court concluded that there were “plausible readings” of the subsections of the automatic stay other than subsection (a)(3) that did not “preclude the Plaintiffs’ Complaint.” The court proceeded to analyze whether the Plaintiffs had stated claims under those subsections.
Section 362(a)(4)
Acts to “create, perfect, or enforce any lien against property of the estate” violate the automatic stay under subsection (a)(4). The court questioned “whether the City’s continued possession is an act to create, perfect, or enforce that lien” because it was undisputed that the vehicles were property of the Plaintiffs’ estates. The court therefore denied the City’s motion to dismiss as to this claim because the Plaintiffs plausibly alleged that by continuing to retain their vehicles, the City may have acted to perfect its liens on their vehicles under the possessory-lien ordinance pursuant to which the City’s liens arose.
Section 362(a)(6)
Acts to “collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title” violate the automatic stay under subsection (a)(6). The court questioned whether the City’s holding of the vehicles amounted to an “act to collect, assess, or recover a claim” because it was undisputed that the City had pre-petition claims against the Plaintiffs. The court therefore denied the City’s motion to dismiss as to this claim, not only because the City had demanded payment of fees as a condition of release, but because the City’s possessory-lien ordinance allowed third-party lienholders to obtain release of the Debtors’ vehicles by paying only the City’s towing costs. In contrast, the Debtors were required to pay all of their outstanding fines. This suggested to the court that the City’s refusal to release the Debtors’ vehicles was designed to compel them to pay the City’s claims.
Section 362(a)(7)
“[T]he setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor” violates the automatic stay under subsection (a)(7). In addition to the other requirements for setoff, the court stated that the City must have intended any setoff to be permanent in order to violate the automatic stay under this subsection. The court therefore granted the City’s motion to dismiss as to this claim because the Debtors had not alleged any facts suggesting that the City had intended a permanent setoff by retaining possession of their vehicles. However, it allowed the Debtors to amend their complaint because it could “hypothesize a set of facts consistent with the allegations of the Complaint that might establish the requisites for a claim under section 362(a)(7).”
Conclusion
Accordingly, and for other reasons stated in its opinion, the court declined to extend the Supreme Court’s ruling in Fulton to the other subsections of the automatic stay and largely denied the City’s motion to dismiss.
11 U.S.C. § 362
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—
. . .
(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title;
. . . .
. . . .
(k) (1) Except as provided in paragraph (2), an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.
(2) If such violation is based on an action taken by an entity in the good faith belief that subsection (h) applies to the debtor, the recovery under paragraph (1) of this subsection against such entity shall be limited to actual damages.
See also Phila. Newspapers, 407 B.R. at 611 (noting that “[c]ourts have often conflated” the second and third parts of the analysis, but explaining that “each step of the inquiry is distinct, independently necessary, and implicates different interests” because section 105(a) is neither a source of jurisdiction, nor a “repository of any substantive rights,” and instead empowers the bankruptcy court to issue injunctions as necessary to carry out the other provisions of the Bankruptcy Code). ↑
The elements of collateral estoppel include that “(1) the issue decided in the prior case is identical to the one presented in the later case; (2) there was a final judgment on the merits in the prior action; (3) the party against whom collateral estoppel is asserted was a party to the prior action, or is in privity with a party to the prior action; and (4) the party against whom collateral estoppel is asserted had a full and fair opportunity to litigate the issue in the prior action.” ↑
In addition to the two parties’ arguments, the Producers Guild of America, Inc. (the PGA) filed an amicus brief asserting one additional argument in support of Cohen. The PGA explained that in this field producers place reliance on the ongoing materiality of specific provisions within these types of agreements. Any deviation from recognizing and enforcing these provisions would undermine the intent of the parties and threaten the viability of both the contracts and the production of the movies they support. ↑
The Restatement’s test is also controlling under Pennsylvania state law. E.g., Gamesa Energy USA, LLC v. Ten Penn Ctr. Assocs., L.P., 217 A.3d 1227, 1231 (Pa. 2019). ↑
The factors of the test include “(a) the extent to which the injured party will be deprived of the benefit which he reasonably expected; (b) the extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived; (c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture; (d) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances; [and] (e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.” Restatement (Second) of Contracts § 241 (Am. Law Inst. 1981). ↑
The Trustee also moved the Bankruptcy Court to assert jurisdiction over the Debtor and all of its assets to the exclusion of the District Court. The Bankruptcy Court determined that the Department had engaged in forum shopping, and that the District Court had interfered with the Bankruptcy Court’s exclusive jurisdiction over the Debtor’s estate because the Department’s suit was merely an action to collect a debt rather than an exercise of police power. However, the Bankruptcy Court declined to enter an order and instead referred the case to the United States District Court for the Southern District of Florida. ↑
Southlake later withdrew the attachment after Margavitch obtained confirmation of a chapter 13 plan providing for payment of Southlake’s claim in full. ↑
The Plaintiffs had amended the complaint after issuance of the Supreme Court’s decision in City of Chicago v. Fulton, 141 S. Ct. 585 (2021), to remove a cause of action under subsection (a)(3). ↑
