United States: Compilation Of Recent Developments In Bankruptcy Law - January 2023

1. AUTOMATIC STAY

1.1 Covered Activities

1.1.a Court declines to enjoin third party claims against the debtor's jointly liable parent corporation. The debtor manufactured earplugs for many years. A major multinational corporation acquired it. Two years later, it transferred its earplug manufacturing operation to its parent. Although the parent continued to manufacture and sell the earplugs, 80% of the sales occurred before the transfer. The earplugs were ineffective, resulting in hundreds of thousands of product liability actions against the debtor and the parent in both state and federal court, with the federal actions consolidated under an MDL procedure. The debtor and the parent entered into a funding agreement, which provided that the parent would fund up to $1 billion to a plaintiffs' recovery trust and up to $240 million for the debtor's chapter 11 fees and expenses, and the debtor would indemnify the parent for any claims against the parent but could draw funding from the parent to pay any indemnification claims, with no repayment obligation (in effect, a circular transaction). In addition, the debtor and parent shared insurance policies that would cover a substantial amount of claims. Upon filing its petition, the debtor sought to apply the automatic stay to, or to affirmatively enjoin, the prosecution of the product liability actions against the parent. Section 362(a)(1) enjoins only litigation against the debtor, not third parties, unless (in some circuits) there is such an identity of interest that a judgment against the third party would amount to a judgment against the debtor or would cause the debtor irreparable harm. Circuit authority here does not extend the (a)(1) stay, so the court declines to apply it. Section 362(a)(3) stays acts to obtain possession of or exercise control over property of the debtor. Here, because the parent, under the funding agreement, will ultimately fund any liability imposed on the debtor, the tort litigation will not affect the debtor's property or its ability to pay claims. Section 105(a) permits the court to issue any order necessary to carry out the provisions of title 11, but the court must first have jurisdiction. A court has jurisdiction over an action if it is related to the title 11 case, that is, if the outcome could have any conceivable effect on the case, the debtor's assets, or claims. Because of the debtor's ability to access funds under the funding agreement, the tort litigation would not have any such effect. Therefore, the court denies any order staying the tort litigation. 3M Occupational Safety LLC v. Those Parties Listed on Appendix A to the Complaint (In re Aearo Techs. LLC), 642 B.R. 891 (Bankr. S.D. Ind. 2022).

1.1.b Automatic stay is not enforceable in the U.S. against a foreign creditor. The debtor borrowed money in Ireland, securing the loan by various Irish assets. When he defaulted, his Irish creditors pursued and obtained remedies in the Irish courts. The debtor filed a chapter 11 petition to attempt to stay any further foreclosure actions and sued the Irish creditors in the bankruptcy court for contempt for violating the stay. The automatic stay prohibits any act to exercise control over property of the debtor or property of the estate. Property of the estate includes any interest of the debtor in property, wherever located. Therefore, the automatic stay applies to protect the debtor's Irish property. However, a court may not enforce violations of the stay against creditors or other defendants over whom the court does not have personal jurisdiction. Here, the Irish creditors and other actors had no U.S. contacts and so were not subject to an enforcement action in the U.S. courts. Sheehan v. Breccia Unltd. Co. (In re Sheehan), 48 F.4th 513 (7th Cir. 2022).

1.1.c Authorizing issuance of additional shares in the debtor's corporation does not violate the stay. The individual debtor, who had embezzled substantial sums from a corporation while he was an officer, owned a 23% interest in the corporation. That interest became property of the estate. The majority shareholder adopted a resolution increasing the number of authorized shares in the corporation but took no action to issue any additional shares. The automatic stay prohibits any act to obtain possession of or exercise control over property of the debtor or of the estate. Merely authorizing the issuance of additional shares does not dilute the estate's interest in the corporation and therefore does not violate the stay. Because the corporate action did not contemplate issuance of new shares, the court did not need to address the issue of whether such an action would have violated the stay. In re Harrison, 643 B.R. 399 (Bankr. E.D. N. Car. 2022).

1.1.d False advertising to the debtor's customers does not violate the stay. The debtor provided telecommunications services to its customers. After its bankruptcy, its competitor sent advertisements to the debtor's customers implying that the debtor would be going out of business and would not be able to provide services. The automatic stay prohibits any act to obtain possession or control of property of the estate, including any act or proceeding that might dissipate the estate's assets. It protects both executory contracts and goodwill. However, a competitor's competitive efforts to attract customers, standing alone, does not interfere with the debtor's contracts with its customers, and its general advertising questioning the debtor's future longevity does not attempt to obtain possession of or exercise control over the debtor's goodwill. Not every illegal act violates the stay: nothing in the stay suggests that improper advertisements are attempts to obtain control but legitimate ones are not. Therefore, the competitor did not violate the stay. Windstream Holdings, Inc. v. Charter Commc'ns Inc. (In re Windstream Holdings, Inc.), 2022 U.S. Dist. LEXIS 183574 (S.D.N.Y. Oct. 6, 2022).

1.1.e Order granting counterclaim declaring validity of mortgage on the debtor's property does not violate the stay. The debtor acquired property subject to a disputed mortgage. The debtor brought a quiet title action against the mortgagee. The mortgagee counterclaimed to declare the mortgage valid. While summary judgment motions were pending, the debtor filed a chapter 11 case. The nonbankruptcy court granted summary judgment to the mortgagee after the debtor's petition date. The automatic stay prohibits continuation of any action against the debtor that was or could have been commenced before the petition date, any act to obtain possession or exercise control of property of the estate, and any act to create, perfect, or enforce a lien against property of the debtor. Because the mortgagee's counterclaim was simply the mirror image of the debtor's complaint, did not seek additional relief, and was only a defense to the complaint, the mortgagee's counterclaim was not an action against the debtor. The counterclaim also sought only to maintain the status quo and as such, did not constitute an act to obtain possession or control of property of the debtor or the estate. It simply affirmed the validity of an existing lien. Finally, the judgment on the counterclaim did not create, perfect, or enforce a lien on the debtor's property. It only declared existing rights. Therefore, the nonbankruptcy court's summary judgment order did not violate the stay. Censo, LLC v. Newrez, LLC (In re Censo, LLC), 638 B.R. 416 (9th Cir. B.A.P. 2022).

1.1.f Taggart v. Lorenzen standard applies to stay violation in a corporate case. The debtor sold assets prepetition. After the petition date, the buyer demanded payment of certain working capital adjustments provided under the purchase agreement. The automatic stay prohibits any act to collect or recover a prepetition claim. Section 362(k) allows an individual debtor to recover damages for willful violation of the stay. Under Sixth Circuit law, it does not protect non-individual debtors. Therefore, the remedy for a stay violation in a non-individual debtor case is a civil contempt citation under section 105(a). Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), applied the general standards for a civil contempt citation to a violation of the discharge injunction, permitting a contempt finding only if the actor had no objectively reasonable basis on which to assert the discharge injunction did not apply. But in dicta, the decision distinguished automatic stay violations in individual debtor cases, suggesting a strict liability standard might be appropriate. Because section 362(k) does not apply in non-individual debtor cases, the distinction does not apply; the general civil contempt standards apply. In this case, compliance with the purchase agreement regarding purchase price adjustments would not violate the stay, but the belated demand for payment did. However, the seller had an objectively reasonable basis to conclude that the action did not violate the stay. Therefore, the court denies the request for sanctions. Harker v. Eastport Holdings, LLC (In re GYPC, Inc.), ___ B.R. ___ (Bankr. S.D. Ohio Nov. 22, 2021).

1.1.g Refusal to quash a prepetition garnishment writ does not violate the stay as long as the creditor stays all proceedings. Before bankruptcy, the creditor obtained a writ of garnishment and garnished the debtor's bank account. The bank froze the account, but before it turned over any funds to the creditor, the debtor filed a bankruptcy petition. The creditor requested the state court stay the proceedings and advised the court that it had no objection to the bank's release of the funds, but it would not quash its writ or direct the bank to release the funds. The court stayed the proceedings, granted the debtor's request to quash the writ, and denied the debtor's request for a return of the funds. However, the bank unfroze the account a few days later. The automatic stay prohibits (1) a creditor from commencing or continuing an action to collect a prepetition debt, (2) enforcement against the debtor of a prepetition judgment, (3) any act to obtain possession of property of the estate or from the estate or to exercise control over such property, and (6) any act to collect or recover a prepetition claim. City of Chicago v. Fulton, 141 S. Ct. 585 (2021), held that section 362 requires a creditor holding property of the debtor or the estate to maintain the status quo but does not require turnover of the property, which is governed instead by section 542. Refusing to quash the garnishment was not the continuation of a prepetition action, nor is it an attempt to enforce a prepetition judgment, as long as the creditor stayed all proceedings in the action. Refusal to quash the writ was also not an act to obtain property or an act to collect the debt. Here, the creditor did nothing to change its position, and the debtor's account was unfrozen. Therefore, the creditor did not violate the stay. Stuart v. City of Scottsdale (In re Stuart), 632 B.R. 531 (9th Cir. B.A.P. 2021).

1.1.h The debtor violated numerous state court orders in actions to recover amounts he misappropriated. The state court held him in contempt and imposed monetary sanctions and ordered him to stop managing property he did not own and to turnover proceeds from the illegal management. The debtor filed his bankruptcy petition the day before a state court hearing on sentencing the debtor to jail for contempt. Section 362(a) stays any prepetition action or proceeding against the debtor, but section 362(b)(4) excepts from the stay any action by a governmental unit to enforce its police or regulatory power." The exception applies when the government's action is to effectuate a public policy to protect public safety and welfare or is to further its own interest but not if the government proceeds for a pecuniary purpose to recover property from the estate. The state court is a governmental unit, and its order to stop managing the property was in the interest of public safety. Its order to turn over money that the debtor collected in violation of the state court's order does not reflect a pecuniary purpose, even though money is involved, because it seeks redress of the violation of a court order and therefore comes within the police power exception. Kupperstein v. Schall (In re Kupperstein), ___ F.3d ___, 2021 U.S. App. LEXIS 11944 (1st Cir. Apr. 22, 2021).

1.1.i Automatic stay does not apply to state enforcement of COVID-19 protection measures. The state enacted measures to limit restaurant operations during the COVID-19 pandemic. The debtor disregarded those measures, claiming they were unconstitutional. The county sued in state court to shut down the debtor's operation. The debtor filed chapter 11, invoking the automatic stay. 28 U.S. C. § 959(b) requires a debtor in possession to manage and operate its property "according to the valid laws of the State." Therefore, the safety measures apply to the debtor in possession. Section 362(b)(4) excepts from the automatic stay an action by a governmental entity to enforce its police or regulatory powers. In determining whether an action falls within this exception, the court may not determine the merits of a debtor's challenge to the legality of the state law. Nothing in section 362(b)(4) authorizes the court to examine the legality of the governmental unit's action, which is left to the state court, lest the bankruptcy courts are to scrutinize every governmental regulatory action for legality. Therefore, the county's enforcement action may proceed. Cty of Allegheny v. Cracked Egg, LLC (In re Cracked Egg, LLC), 624 B.R. 84 (Bankruptcy W.D. Pa. 2021).

1.1.j Section 362(a)(3) does not require turnover of property of the estate. The city impounded the debtor's vehicle for nonpayment of traffic fines. The debtor filed a chapter 13 petition and demanded turnover of the car. Section 362(a)(3) stays any act to "exercise control over property of the estate." Section 542(a) requires one in possession of property of the estate to deliver it to the trustee. The most natural reading of section 362(a)(3) is that it prohibits affirmative acts that alter the status quo and does not impose an affirmative obligation on a party holding property of the estate to turn it over. Section 542(a) performs that function. Therefore, the city may retain the vehicle without violating the automatic stay. City of Chicago v. Fulton, 592 U.S. ___140 S. Ct. 2017 (2021).

1.1.k Automatic stay applies to state court litigation between equity holders over control of the debtor and its property. A faction in control of the debtor church brought litigation in state court against another faction for a determination that the debtor faction had control of the church and its property to the exclusion of the other faction. Section 362(a)(3) stays any act to obtain control over property of the debtor or of the estate. Although the faction currently in control of the debtor was the plaintiff, the litigation involved control over the debtor and its property and was therefore subject to the automatic stay. The litigation differed from other corporate control litigation, such as whether to hold a shareholder meeting or whether to permit the voting of pledged shares, to which the automatic stay does not apply. In re Korean W. Presbyterian Church of L.A., 619 B.R. 282 (Bankr. C.D. Cal. 2020).

1.1.l FERC proceeding to restrict rejection of a power purchase agreement may be subject to the automatic stay. The debtor had entered into several agreements to purchase power it no longer needed because its reorganization contemplated its exit from the business of selling electricity at retail. The contracts constituted a minimal portion of the debtor's power contracts and were an insignificant portion of the power market. Upon filing its chapter 11 petition, it sought to enjoin FERC from any action regarding the contracts, including any proceeding to prevent rejection in the chapter 11 case or to require the debtor to perform the contracts. The automatic stay prohibits any act to enforce a prepetition obligation, but an action by a governmental unit to enforce its police or regulatory power is excepted from the stay if the action is to effectuate public policy rather than adjudicate private rights. Although FERC enforces public policy through its determination of whether power agreements are just and reasonable in the public interest, the minimal effect of these contracts on the power markets suggests that any FERC role here would be to vindicate the private interests of the contract counterparties, rather than public policy, so the bankruptcy court may properly enjoin FERC from prohibiting rejection and from ordering the debtor in possession to continue to perform the contract after rejection. However, the bankruptcy court's injunction may not deprive FERC of its own jurisdiction to determine whether the automatic stay applies nor prohibit FERC from taking any action whatsoever or enjoin all FERC's regulatory functions. F.E.R.C. v. FirstEnergy Solutions Corp. (In re FirstEnergy Solutions Corp.), 945 F.3d 431 (6th Cir. 2019).

1.1.m Bankruptcy court may grant stay relief to permit creditors to pursue trustee's avoiding power actions. The debtor was the subject of an LBO. In connection with the LBO tender offer, the debtor retained as "depositary" a trust company, which performed multiple services for the debtor, including receiving the tendered shares and paying shareholders. Within a year after the LBO, the debtor filed a chapter 11 case. The creditors committee, on behalf of the estate, brought actual fraudulent transfer actions under section 548(a)(1)(A) against the cashed-out shareholders. The bankruptcy court granted creditors stay relief to bring constructive fraudulent transfer actions in nonbankruptcy courts against the cashed-out shareholders, which they did. Whether or not the automatic stay prohibits creditors from pursuing fraudulent transfer actions creditors had before bankruptcy, the bankruptcy court's stay relief permitted creditors to pursue the actions. In re Tribune Co. Fraudulent Conveyance Litigation, 946 F.3d 66 (2d Cir. 2019).

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