September 2013: Bankruptcy & Restructuring Litigation Update - Second Circuit Addresses the Scope of the Bankruptcy Automatic Stay.

by Quinn Emanuel Urquhart & Sullivan, LLP
Contact

The automatic stay triggered upon the filing of a voluntary bankruptcy petition is one of the fundamental protections available to a debtor. The automatic stay generally prohibits “the commencement or continuation ... of a judicial, administrative, or other action or proceeding against the debtor” and bars “any act to obtain possession of property of the estate.” 11 U.S.C. § 362(a). This benefit is intended to give the debtor a breathing spell and brings all of the assets of the debtor and claims against it into a single forum, the bankruptcy court, for resolution.

The automatic stay is a “debtor” protection. The literal language of § 362(a) does not extend the automatic stay to non-debtor entities that have not commenced bankruptcy cases but that may be affiliated with the debtors. Some courts have nevertheless interpreted § 362(a) to protect a non debtor where continuing a lawsuit against it would impede the debtor’s orderly reorganization or liquidation; other courts have invoked their equitable power under 11 U.S.C. § 105(a) to achieve the same result. But the scope of a bankruptcy court’s authority to enjoin actions against a non debtor is far from settled. A recent decision by the Second Circuit, In re Residential Capital, LLC, --- Fed. Appx. ---, 2013 WL 3491311(2nd Cir. July 15, 2013), declined to impose a per se rule against the imposition of the automatic stay in favor of a non-debtor and instead determined that a case-by-case assessment is necessary to determine the applicability of the automatic stay to a non-debtor.

Residential Capital, LLC and its affiliate debtors (the “Debtors” or “ResCap”) were one of the largest originators and servicers of residential mortgage loans in the country. Residential mortgage-backed securities issued by ResCap depreciated in value as a result of the 2007-2008 financial crisis. These market losses prompted the filing of a number of lawsuits against ResCap, their corporate parents and/or their officers and directors. On May 14, 2012, the Debtors filed their petitions for relief under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”), citing exposure to these lawsuits as a reason for the bankruptcy filing.

One of the lawsuits against ResCap was commenced by the Federal Housing Finance Agency (“FHFA”). In addition to naming the Debtors as defendants, FHFA also sued certain direct and indirect corporate parents and an affiliate of the Debtors (the “Non-Debtor Defendants”). FHFA removed the Debtors as defendants and sought to continue the lawsuit against the Non-Debtor Defendants. The Debtors in turn moved the Bankruptcy Court to enter a declaratory judgment extending the automatic stay to the Non-Debtor Defendants under both §§ 362(a) and 105(a), even though the Debtor Defendants were no longer part of the lawsuit.

The United States District Court for the Southern District of New York (the “District Court”) withdrew the Debtors’ motion from the Bankruptcy Court and assumed jurisdiction. In a bench decision, the District Court denied the Debtors’ motion. The District Court reasoned that because FHFA did not continue the lawsuit against the Debtors, the property of the bankruptcy estates was not at risk; as a result the automatic stay under § 362(a) could not as a matter of law be extended to the Non-Debtor Defendants.

The Debtors appealed to the Second Circuit, arguing that continuation of the proceeding against the Non-Debtor Defendants would nonetheless impede the Debtors’ prospects for successful reorganization. The Debtors argued they would bear the burden of discovery because the documents sought by FHFA were in their possession, and the extensive depositions to which the Debtors’ key personnel would be subject could distract them from focusing on the Chapter 11 process. The Debtors further cited their contractual liability to indemnify the Non-Debtor Defendants for legal costs and any judgment and potential depletion of insurance coverage available to the Debtors as the Debtors and the Non-Debtor Defendants were co-insureds under a number of policies that had a first billed, first paid provision.

The Second Circuit agreed, concluding the District Court erred by failing to make factual findings and holding as a categorical matter that the automatic stay set forth in § 362(a) cannot be applied. 2013 WL 3491311 at *1 (“[There] are no explicit findings with regard to ResCap’s request under Section 362(a).”). The Second Circuit relied upon preexisting Circuit case-law which applied the automatic stay to a debtor’s wholly owned subsidiary on the basis that “a claim against the non-debtor will have an immediate adverse economic consequence for the debtor’s estate.” Id. (quoting Queenie, Ltd. v. Nygard Int’l, 321 F.3d 282, 287 (2d Cir. 2003)). The Second Circuit remanded the case to the District Court and requested that the appropriate fact-findings be entered within 60 days. Id. It expressed no view on whether the Non-Debtor Defendants are entitled to have the lawsuit against them enjoined. Id. (“[W]e do not have to reach that question until” until the requisite findings are made).

The decision confirmed that the automatic stay may be extended to a non-debtor if permitting the litigation to continue against it would impose an “immediate adverse consequence” on the estate. A party to a lawsuit with both debtor and non-debtor defendants cannot avoid application of the automatic stay by simply dropping the debtor defendants and proceeding with the action against the non-debtor entities in lieu of the debtor entities. This decision further clarifies that the Second Circuit’s application of the automatic stay to a non-debtor on the basis of “immediate adverse consequence” to the estate is not necessarily limited to the context of where the non-debtor is a wholly owned subsidiary of the debtor.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Quinn Emanuel Urquhart & Sullivan, LLP | Attorney Advertising

Written by:

Quinn Emanuel Urquhart & Sullivan, LLP
Contact
more
less

Quinn Emanuel Urquhart & Sullivan, LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!