In Brief: First Circuit Rules That Section 1109(b) of the Bankruptcy Code Creates an Unconditional Right to Intervene in an Adversary Proceeding

by Jones Day
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Jones DayIn Assured Guaranty Corp. v. Fin. Oversight & Mgmt. Bd. for Puerto Rico, 872 F.3d 57 (1st Cir. 2017), the U.S. Court of Appeals for the First Circuit ruled that section 1109(b) of the Bankruptcy Code gave an unsecured creditors’ committee an "unconditional right to intervene," within the meaning of Fed. R. Civ. P. 24(a)(1), in an adversary proceeding commenced during the course of a bankruptcy case. The court reversed a district court order denying a motion to intervene filed by the official committee of unsecured creditors appointed in the quasi-bankruptcy cases filed on behalf of certain Puerto Rico instrumentalities under the Puerto Rico Oversight, Management, and Economic Stability Act, 48 U.S.C. §§ 2161–2177 ("PROMESA"). The First Circuit’s decision deepens a circuit split on whether an official committee’s unconditional right to intervene applies to adversary proceedings.

The Right to Be Heard in Chapter 11 and Intervention

Section 1109(b) of the Bankruptcy Code provides that " [a] party in interest, including the debtor, the trustee, a creditors’ committee, an equity security holders’ committee, a creditor, an equity security holder, or any indenture trustee, may raise and may appear and be heard on any issue in a case under this chapter."

This provision expressly provides any party in interest with an unconditional right to participate in a chapter 11 "case." "Case" refers to "litigation commenced by the filing with the bankruptcy court of a petition under the appropriate chapter of Title 11." Term Loan Holder Comm. v. Ozer Grp., L.L.C. (In re Caldor Corp.), 303 F.3d 161, 167 (2d Cir. 2002) (internal quotation marks and citations omitted). By contrast, an "adversary proceeding" in bankruptcy is discrete litigation commenced during a bankruptcy case to, among other things: recover money or property (e.g., avoid fraudulent or preferential transfers); determine the validity, priority, or extent of a lien or other interest in property; revoke an order confirming a chapter 11 plan; or obtain injunctive relief. See Fed. R. Bankr. P. 7001.

"Intervention" is a procedure that permits a nonparty to join ongoing litigation, either as a matter of right or at the discretion of the court, without the permission of the original litigants, generally because a judgment in the case may impact the rights of the nonparty intervenor. The ability to intervene in federal litigation is generally governed by Fed. R. Civ. P. 24, which is made applicable in its entirety to adversary proceedings commenced in a bankruptcy case by Fed. R. Bankr. P. 7024.

Fed. R. Civ. P. 24(a) provides that the court "must permit anyone to intervene who . . . is given an unconditional right to intervene by a federal statute." Rule 24 also provides for intervention as a matter of right if necessary to protect a nonparty’s interest in property that is the subject of the litigation, as well as for permissive intervention under certain circumstances.

Because section 1109(b) says nothing about "proceedings," some courts, noting the general distinction between cases and proceedings, have concluded that the provision applies only to bankruptcy cases and does not create an unqualified right to intervene in adversary proceedings. See Fuel Oil Supply & Terminaling v. Gulf Oil Corp., 762 F.2d 1283 (5th Cir. 1985). Two other circuits have, in dicta, suggested that they agree with the Fuel Oil approach. See Richman v. First Woman’s Bank (In re Richman), 104 F.3d 654, 658 (4th Cir. 1997); Vermejo Park Corp. v. Kaiser Coal Corp. (In re Kaiser Steel Corp.), 998 F.2d 783, 790 (10th Cir. 1993).

However, both the Second and Third Circuits have rejected the reasoning in Fuel Oil, ruling instead that section 1109(b) provides a statutory right to intervene in adversary proceedings for purposes of Fed. R. Civ. P. 24(a)(1). See Caldor Corp., 303 F.3d at 176; Phar-Mor, Inc. v. Coopers & Lybrand, 22 F.3d 1228, 1240 (3d Cir. 1994). In Caldor, the Second Circuit explained that "the plain text of § 1109(b) does not distinguish between issues that occur in . . . different types of proceedings within a Chapter 11 case," concluding that the provision applies to adversary proceedings as well as bankruptcy cases. 303 F.3d at 169.

PROMESA

PROMESA was enacted in June 2016 to help Puerto Rico manage its financial crisis after the U.S. Supreme Court struck down as unconstitutional a 2014 Puerto Rico law, portions of which mirrored chapter 9 of the Bankruptcy Code, that would have allowed the commonwealth’s public instrumentalities to be restructured. PROMESA provides for the establishment of a Financial Oversight and Management Board entrusted with determining the adequacy of budgets and fiscal plans for Puerto Rico and certain of its instrumentalities. It also provides a mechanism for the implementation of voluntary out-of-court restructuring agreements between an instrumentality and its bondholders, as well as bond debt adjustment plans (consensual and nonconsensual) in a case commenced in federal district court under Title III of the statute.

PROMESA expressly makes applicable in a Title III debt restructuring case many provisions of the Bankruptcy Code, including section 1109, as well as the entirety of the Federal Rules of Civil Procedure.

On May 3, 2017, the Financial Oversight and Management Board for Puerto Rico filed voluntary petitions for relief under Title III of PROMESA in the District of Puerto Rico on behalf of certain Puerto Rico instrumentalities. The same day, insurers of Puerto Rico bonds commenced an adversary proceeding, alleging that the commonwealth’s proposed fiscal plan violated various provisions of PROMESA and the U.S. Constitution and seeking declaratory and injunctive relief to prevent the implementation of that plan.

The official committee of unsecured creditors (the "committee") appointed in the Title III cases in June 2017 moved to intervene in the adversary proceeding, arguing that Fed. R. Civ. P. 24(a)(1) and section 1109(b) gave the committee "an unconditional right to intervene." The insurer plaintiffs opposed the motion to intervene.

District judge Laura Taylor Swain (sitting by designation) denied the motion to intervene. She said she was bound to do so by a footnote in Kowal v. Malkemus (In re Thompson), 965 F.2d 1136, 1142 n.8 (1st Cir. 1992), where the First Circuit (which exercises appellate jurisdiction over the District of Puerto Rico) stated that section 1109(b) "does not afford a right to intervene under Rule 24(a)(1)."

A three-judge panel of the First Circuit reversed on appeal. According to the panel, although apparently on point, the footnote that Judge Swain relied upon in Thompson was nonbinding dicta because Thompson involved an appeal in a chapter 7 case, and thus section 1109(b) was "inapplicable on its face." The panel also distinguished other decisions in which the courts have cited Fuel Oil with approval. Richman, like Thompson, the First Circuit panel noted, was a chapter 7 case, "so § 1109(b) was facially incapable of providing the requisite statutory right of intervention." In Kaiser, the panel explained, the Tenth Circuit held that the putative appellants were not parties in interest and therefore were not entitled to the rights conferred by section 1109(b).

Therefore, the First Circuit panel examined whether section 1109(b) confers an unconditional right to intervene in an adversary proceeding. After considering the conflicting decisions on the issue, the panel found the Second and Third Circuits’ position more persuasive. The panel explained that the text of section 1109(b) applies generally to "cases," a term which encompasses all litigation commenced by the filing of a chapter 11 petition. It agreed with a leading commentator that, "[b]ecause every issue in a case may be raised and adjudicated only in the context of a proceeding of some kind, it is apparent that the reference . . . to ‘any issue in a case’ subsumes issues in a proceeding" (citing Collier on Bankruptcy ¶ 1109.04[1][a][ii]).

On the basis of this reasoning, the First Circuit panel ruled that "§ 1109(b) provides the [committee] with an ‘unconditional right to intervene’ in the adversary proceeding."

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.

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