Jurisdiction Retention Clause in Sale Order Can’t Provide Bankruptcy Court Subject Matter Jurisdiction for Contract Disputes between Non-Debtors

by Kramer Levin Naftalis & Frankel LLP

Kramer Levin Naftalis & Frankel LLP

The Bottom Line

In a decision addressing the reaches of bankruptcy court subject matter jurisdiction, a First Circuit Panel, including retired Supreme Court Justice Davis Souter sitting by designation, ruled that the bankruptcy court’s subject matter jurisdiction did not extend to determining contractual rights under an asset purchase agreement, even where the sale order approving the sale pursuant to sections 363 and 365 of the Bankruptcy Code contained express provisions regarding the retention of jurisdiction by the bankruptcy court over any disputes arising thereunder.

What Happened?

In Gupta v. Quincy Med. Ctr., 2017 U.S. App. LEXIS 9814, 2017 WL 2389407 (1st Cir. Mass. June 2, 2017), the Debtors, Quincy Medical Center, signed an Asset Purchase Agreement (the “APA”) in which they agreed to sell substantially all of their assets to Quincy Medical Center, a Steward Family Hospital, Inc. f/k/a Steward Medical Holdings Subsidiary Five (the “Purchaser”).  The following day, the Debtors filed voluntary petitions under Chapter 11 of the Bankruptcy Code, as well as a motion seeking court approval of the APA.  On September 26, 2011, the bankruptcy court entered the Sale Order which contained a provision providing that the bankruptcy court retained jurisdiction over any disputes arising under the APA and the Sale Order.  The Sale Order stated that:

It is necessary and appropriate, in order to ensure the validity of the sale of the Assets to Steward and to ensure compliance with this Order, for this Court to retain jurisdiction to: (a) interpret and enforce the provisions of the APA, the Assigned Agreements, the Sale Motion and this Order; (b) protect Steward and any of the Assets against any Lien or Claim; (c) resolve any disputes arising under or relating to the APA, the Assigned Agreements, the Sale Motion and this Order; and (d) determine the validity, extent and priority of asserted pre-Closing Liens or Claims on, and the disposition of the gross proceeds of sale of, the Assets.

The asset sale closed six days later on October 1, 2011.  The approved Plan also included a retention of jurisdiction clause and that clause was incorporated into the Confirmation Order.

Sections 5 and 9 of the APA dealt with the employment of the Debtors’ former employees.  Pursuant to those sections, the Purchaser would offer employment to all employees who remained employed by the Debtors as of an established date.  Each of the employees would receive the salary that was provided to the employees immediately prior to closing for at least three months.  Additionally, if the Purchaser terminated any of the employees following closing, the Purchaser would be responsible for any severance payments due. 

Shortly after the sale closed, the appellants, Apurv Gupta and Victor Munger, both senior executives of the Debtors, received letters from the Debtor that their employment was terminated effective as of the closing of the sale.  Gupta and Munger promptly filed motions to allow their severance payments as administrative claims.  The bankruptcy court denied administrative status to their claims but allowed the motions to be treated as motions seeking an order directing the Purchaser to pay the claims.  The bankruptcy court believed that it had subject matter jurisdiction over the matter because of the retention of jurisdiction provisions in the Sale Order.  After briefing on the issue, the bankruptcy court ruled that the Purchaser was liable for the severance pay.  Purchaser appealed the decision and the district court determined that the bankruptcy court lacked subject matter over the Appellants’ claims and therefore reversed the ruling.  Gupta and Munger then appealed the ruling to the First Circuit.

In evaluating the issue, the First Circuit first described the circumstances under which a bankruptcy court has subject matter jurisdiction.  The First Circuit determined that, pursuant to 28 U.S.C. Section 1334, in order for a bankruptcy court to have subject matter jurisdiction, the claims must either: (1) “arise under,” (2) “arise in,” or (3) “relate to” a case under title 11.  Claims that arise under a case under title 11 are claims where the cause of action itself is created by the Bankruptcy Code and its statutory provisions.  Claims that arise in a case under title 11 are claims that while not specifically created by a provision of the Bankruptcy Code, would only arise in the context of a bankruptcy case.  Finally, related to subject matter jurisdiction allows for claims that may have an effect on the bankruptcy estate or its administration.

While the bankruptcy court had determined that subject matter jurisdiction existed solely as a result of the jurisdiction provision in the Sale Order, the First Circuit disagreed.  Instead, the First Circuit determined that there is no ability to create subject matter jurisdiction as a result of such a clause where none exists under 28 U.S.C. Section 1334.  Therefore, the First Circuit went on to analyze whether subject matter jurisdiction existed as a result of any of the three possible categories.

The Appellants did not try to argue that subject matter jurisdiction existed based on the claims arising under or relating to the chapter 11 case. The First Circuit agreed with this because it felt that the claims clearly did not arise under the Bankruptcy Code and, because they were asserted against the non-debtor Purchaser, had no effect on the bankruptcy estate.

Instead, Appellants argued that the claims arose in the chapter 11 case because the APA was approved under Sections 363 and 365 of the Bankruptcy Code and “but for [the] Debtors’ Chapter 11 case and the Sale Order approving the sale of Debtors’ assets to Steward in the APA, their claims for severance pay would never exist.”

The First Circuit, however, disagreed and rejected Appellants’ “but for” test.  Arising in jurisdiction meant that the relevant proceeding had “no existence outside of bankruptcy.”  The fact that a dispute would not have arisen were it not for the bankruptcy filing does not mean that arising in jurisdiction exists.  The question relates to the nature of the claims and whether they could only arise in the bankruptcy context, not whether the particular factual scenario under which the claims arise in this instance happen to occur in connection with the bankruptcy proceeding.  Because Appellants’ claims rested entirely on interpretation of the APA and state contract law, it was clear that nothing therein related specifically to the bankruptcy context and no arising in jurisdiction existed.

In a footnote, the First Circuit also emphasized that their decision was strengthened by the fact that, while the appeal was pending, Appellants had already filed the same lawsuit against the Purchaser in state court, which had granted summary judgment in the Purchaser’s favor.  That decision had rested entirely on state law principles and interpretation of the APA and did not analyze any bankruptcy related provisions (including the Sale Order).      

Why the Case is Interesting

In recent years, more and more chapter 11 cases are resolved through “distressed M&A” and section 363 sales as going concerns.  An important aspect of these cases concerns assumption of liabilities that could otherwise burden the debtors’ estates, especially administrative liabilities.  It is common for these agreements to address the treatment of employees, including claims for severance (which can be treated as administrative obligations depending upon the Circuit).  Treatment of these claims, in turn, can affect the ability of debtors to confirm a liquidating plan.  In other words, assumption or alleviation of liabilities represent important provisions of an APA.  In addition, debtors routinely include provisions in bankruptcy court approved contracts, plans and orders which provide that the bankruptcy court retains jurisdiction over disputes related to the underlying document or transaction.  In this practical (and important) context, the First Circuit has determined that retention of jurisdiction provisions can only be given effect where the underlying jurisdiction (being retained) already exists under 28 U.S.C. Section 1334.  This places a significant limitation on the parties’ control over where future disputes between parties other than the debtor may be heard, despite the parties’ efforts to ensure that the matter remains with the bankruptcy court already familiar with the agreement or transaction.  It is also interesting to consider how the debtors’ participation may affect situations like this.  In this case, the debtor was not the party seeking to enforce the APA and the matter was treated as a dispute between two non-debtors – the former employees and the purchaser.  Interestingly, this may have occurred because the bankruptcy court treated the motion against the debtor’s estate to be a motion against the purchaser in denying a claim against the debtor for severance.  Had the disputed amounts been obligations that the debtor would have been liable for if not satisfied by the purchaser (or had the debtor been the party seeking to enforce the APA to provide payment), this may have been a distinguishing factor or justification for finding subject matter jurisdiction.

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Kramer Levin Naftalis & Frankel LLP

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