United States: Seventh Circuit Holds Section 105(a) Permits Stay Of Litigation Against Non-Debtor Affiliates

Section 105(a) of the Bankruptcy Code provides that a bankruptcy court "may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title." 11 U.S.C. § 105(a). In the Caesars bankruptcy, the Seventh Circuit explored the breadth of a court's rights to take action under this section. The Seventh Circuit held that section 105(a) permits the Bankruptcy Court to issue an injunction with respect to litigation pending against the debtors' non-debtor parent. The Court of Appeals did not ultimately determine whether the stay should in fact be granted because "that's an issue for the bankruptcy judge to resolve in the first instance;" rather, it held that the Bankruptcy Court and District Court had erred in interpreting section 105(a) too narrowly in denying the stay sought by the debtors. In re Caesars Entm't Operating Co., Inc., No. 15-3259, 2015 WL 9311432 (7th Cir. Dec. 23, 2015).

Background

The case stemmed from events surrounding Caesars Entertainment Operating Company (CEOC), a casino company. Beginning in the mid-2000s and continuing in recent years, CEOC borrowed billions of dollars to finance its operations. In doing so, it issued notes to lenders that were guaranteed by Caesars Entertainment Corporation (CEC), its parent and principal owner. As CEOC's financial position grew increasingly precarious, CEC attempted to eliminate its guaranty obligations by selling assets of CEOC to other parties and terminating the guarantees that it had issued. CEOC's creditors sued CEC, claiming that it was a violation of federal law to abandon the guarantees without unanimous bondholder approval. About five months later, CEOC filed for bankruptcy under chapter 11. In its bankruptcy proceedings, CEOC asserted claims against CEC, alleging that CEC had engaged in a fraudulent transfer by causing CEOC to transfer highly valuable assets to CEC at less than fair value, subsequently saddling CEOC with billions of dollars' worth of debt.

Citing concerns that CEC's guarantors would "thwart[] [CEOC's] multi-billion-dollar restructuring effort, which depends on a substantial contribution from CEC in settlement of [CEOC's] claims against it, and thus . . . jump the line in front of other creditors, including more senior ones. . .", CEOC asked the bankruptcy judge to temporarily enjoin the guaranty suits pursuant to section 105(a).

The bankruptcy judge refused to issue the injunction, reasoning that, while section 105(a) gives judges the right to enjoin litigation against non-debtor parties, he could only do so if the litigation arises out of the "same acts" that gave rise to disputes in the debtor's bankruptcy proceeding. Because the disputes in CEOC's bankruptcy arose out of CEC's alleged fraudulent transfers whereas the disputes in the guarantors' lawsuits arose from CEC's alleged repudiation of the guarantees, the bankruptcy judge believed he lacked the authority to issue the requested injunction. The district judge affirmed.

Analysis

The Seventh Circuit disagreed. Judge Richard Posner, writing for a three-judge panel, described the potential breadth of section 105(a) of the Bankruptcy Code:

[N]othing in 11 U.S.C. § 105(a) authorizes the limitation on the powers of a bankruptcy judge that CEC's creditors . . . successfully urged on the judges below. . . . Though section 105(a) does not give the bankruptcy court carte blanche ... it grants the extensive equitable powers that bankruptcy courts need in order to be able to perform their statutory duties. . . . [The proper question] is whether the injunction sought by CEOC is likely to enhance the prospects for a successful resolution of the disputes attending to its bankruptcy. If it is, and its denial will thus endanger the success of the bankruptcy proceedings, the grant of the injunction would, in the language of section 105(a), be 'appropriate to carry out the provisions' of the Bankruptcy Code, since successful resolution of disputes arising in bankruptcy proceedings is one of the Code's central objectives.

The Seventh Circuit pointed out that CEOC's creditors have a direct and substantial interest in CEC's guaranty litigation, because the less capital CEC has for CEOC to recapture through prosecution or settlement of its fraudulent transfer claims, the less money CEOC's creditors will receive in the bankruptcy proceeding. The court held that "there is nothing in section 105(a) to bar the order sought by CEOC; for the statute . . . authorizes 'any order . . . that is . . . appropriate to carry out the provisions of' the Bankruptcy Code." In vacating the decision below and remanding for further proceedings, the Seventh Circuit concluded that whether or not the temporary injunction is an "appropriate" order is a factual issue to be resolved by the bankruptcy judge in the first instance.

The Seventh Circuit also addressed two cases cited by the guaranty plaintiffs in support of the "same acts" limitation on section 105(a) endorsed by the lower courts.

First, the plaintiffs pointed to Fisher v. Apostolou, 155 F.3d 876 (7th Cir. 1998). In Fisher, the Seventh Circuit affirmed the Bankruptcy Court's injunction under section 105(a), stating that "while the [investor] Plaintiffs' claims [were] not 'property of' the estate [and so were not subject to an automatic stay under 11 U.S.C. § 362], it is difficult to imagine how those claims could be more closely 'related to' it [under 28 U.S.C. § 1334(b)]." Id. at 882. While Fisher was a more "clear-cut" case, the court in Caesars held that "it doesn't follow that a less clear-cut case is necessarily beyond the reach of section 105(a). In both Fisher and [Caesars] the issuance of a temporary injunction against a class of creditors could well facilitate a prompt and orderly wind-up of the bankruptcy."

The plaintiffs also cited In re Teknek, LLC, 563 F.3d 639 (7th Cir. 2009) for support. In Teknek, the court refused to issue an injunction under section 105(a) because the claims against the non-debtor were not sufficiently related to the debtor's bankruptcy. It noted that "alter egos [had] looted both [the bankrupt company] and [the non-bankrupt company][,] ... [which were] separate acts, which caused separate injuries to two separate companies, only one of which [was] in bankruptcy." Id. at 649 (emphasis added).

The Caesars court distinguished Teknek, noting that the litigation regarding CEC's guarantees directly harms CEOC, the debtor, and "concerns transactions that are closely related to, and sometimes overlapping with, those challenged in [CEOC's] bankruptcy." Because the potential injuries to CEOC's creditors and to the guaranty plaintiffs both stem from CEC's broad scheme to transfer CEOC's assets to itself, the Teknek rationale is inapplicable to the present case.

The breadth of section 105 has long been interpreted broadly. However this ruling clearly positions the Seventh Circuit as a court that interprets section 105 even more broadly to protect debtors in chapter 11. The factual scenario in Caesars, i.e. a parent company guaranteeing the obligations of its subsidiary, is very common. Given the Seventh Circuit's decision, a bankrupt subsidiary with any claims against its parent—no matter how unrelated to the subsidiary's bankruptcy—could threaten its creditors' ability to collect on their guarantees.

Five days after the Seventh Circuit issued its decision, CEOC filed an application to set a hearing on an emergency motion for a new ruling on the stay. Judge A. Benjamin Goldgar of the United States Bankruptcy Court for the Northern District of Illinois denied that request without prejudice the very same day. Citing the Federal Rules of Appellate Procedure, Judge Goldgar issued a one-page order which noted that the Seventh Circuit had not yet issued its mandate for a ruling on remand, and that it was not required to do so until at least January 19, 2016. Accordingly, Judge Goldgar concluded that the Bankruptcy Court lacks jurisdiction to address the issue on remand until the mandate issues and is docketed. CEOC subsequently filed a motion for expedited issuance of the mandate, but the Seventh Circuit denied it. We do expect further litigation later this month as the matter makes its way back to the Bankruptcy Court. Whether Judge Goldgar will find that the stay is in fact necessary or appropriate remains to be seen.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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