Shielding Third Parties in Bankruptcy: Extensions of the [section]362 Automatic Stay and Imposing [section]105 Injunctions Under the Bankruptcy Code.

AuthorDorris, Mariane L.

One Sunday night in August 2021, bankruptcy law, plans of reorganization, and third-party releases and injunctions became notoriously part of popular culture when John Oliver, the host of Last Week Tonight with John Oliver, exclaimed the following about the proposed plan of reorganization and incorporated non-consensual releases of third-party, non-derivative claims against non-debtors in connection with the confirmation of a Chapter 11 bankruptcy plan in the bankruptcy case, In re Purdue Pharma, L.P., 633 B.R. 53 (Bankr. S.D.N.Y. 2021): (1)

[T]he really insidious part is that while there are about 400 civil suits naming the Sacklers themselves, the family will agree to the $8 billion settlement only with a non-consensual third-party release precluding all future individual liability. This thing is bullshit because if they get it, all current lawsuits against the Sacklers evaporate, and no future lawsuits can be filed, meaning that the Sacklers, who didn't file for personal bankruptcy themselves, remember, are basically off the hook. And if it sounds weird to you that a company can basically declare bankruptcy and then a bunch of individuals get shielded from liability, that's because it is. (2) While a request for injunctive relief on behalf of non-debtor third parties is not new to bankruptcy courts, the granting of extensions of the automatic stay under 11 U.S.C. [section]362 or injunctions (releases and bar orders) under 11 U.S.C. [section]105 is certainly not commonplace. In Purdue Pharma, along with other relief, the debtors sought and obtained from the bankruptcy court a non-consensual release of third-party non-derivative claims against non-debtors as part of the confirmation of its plan of reorganization. (3) However, on appeal, the district court in In re Purdue Pharma, L.P., 635 B.R. 26, 115 (S.D.N.Y. 2021), overturned the bankruptcy court and held that the Bankruptcy Code neither expressly nor impliedly authorizes a Ch. 11 plan containing such a broad and expansive non-consensual release of third-party non-derivative claims against non-debtors. In its reasoning, the district court rejected the argument that [section]105 and [section]1123 of the Bankruptcy Code support imposing such releases and further relied on the specificity of [section]524(g) and (h), the only Bankruptcy Code sections that expressly authorize third-party releases in limited circumstances (asbestos cases), to hold that none of these sections could be interpreted to provide the court with the expansive authority to impose this broad non-consensual releases of third-party non-derivative claims against non-debtors. (4) Purdue Pharma is now on appeal before the Second Circuit and may ultimately be before the U.S. Supreme Court because of the split of authority among the U.S. courts of appeals on the imposition of injunctions (releases and bar orders) to enjoin a non-consenting third party from asserting claims against non-debtors. (5) Bankruptcy courts are essentially "courts of equity, and their proceedings inherently proceedings in equity." (6) Traditionally, injunctive and equitable relief have been used by bankruptcy courts to accomplish the primary purposes of Ch. 11: 1) preserve going concern; and 2) maximize property available to satisfy creditors. (7) Requests for injunctive relief from bankruptcy courts usually arise in four circumstances: 1) requests to extend the automatic stay provisions of [section]362(a) to third-party non-debtors to prevent a creditor from commencing or continuing litigation against a non-debtor; 2) an adversary proceeding under [section]105(a) seeking an injunction to prevent a creditor from commencing or continuing litigation against a non-debtor or asserting claims against potential property of the bankruptcy estate; 3) a court-approved settlement agreement concluding litigation between the debtor and third parties that contains an injunction (release, bar order, or channeling injunction) permanently enjoining third-party claims against non-debtors under [section]105(a); or 4) a plan of reorganization that contains an injunction (release, bar order, or channeling injunction) permanently enjoining third-party claims against non-debtors under [section]105(a).

Injunctive Relief Under [section]362(a)

While it is "universally acknowledged that an automatic stay of proceedings accorded by [section]362 may not be invoked by entities such as sureties, guarantors, co-obligors, or others with a similar legal or factual nexus to the...debtor," there are "unusual circumstances" in which federal courts have extended the protections of the automatic stay to non-debtor third parties. (8) The primary case establishing this proposition is A.H. Robins Co., Inc. v. Piccinin, 788 F.2d 994 (4th Cir. 1986). In A. H. Robins, the Fourth Circuit determined (in the mass tort context) that where "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 where suit against a third-party defendant sought "possession or control over property of the debtor," a stay may be warranted for the third-party defendant. (9) Unusual circumstances may occur when a non-debtor defendant "is entitled to absolute indemnity by the debtor on account of any judgment that might result against them in the case." (10) Federal courts have also extended the automatic stay to non-debtor third parties where stay protection was deemed essential to the debtor's efforts of reorganization and where the debtor is at risk of being collaterally estopped in later suits. (11)

However, when "unusual circumstances" are not sufficiently present to justify extending the automatic stay provided by [section]362, litigants can still seek a stay of the proceedings against the non-debtor defendants under the court's own inherent authority. As explained by the Supreme Court in Landis v. North Am. Co., 299 U.S. 248, 254-55 (1936):

[T]he power to stay proceedings is incidental to the power inherent in every court to control the disposition of the causes on its docket with economy of time and effort for itself, for counsel, and for litigants. How this can best be done calls for the exercise of judgment, which must weigh competing interests and maintain an even balance. A stay of the proceedings is evaluated based on a balancing test in which the movant bears the burden of showing either "a clear case of hardship or inequity" if the case proceeds, or little possibility the stay will harm others. (12) Courts weigh several factors such as whether a stay will 1)...

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