Subject Matter Jurisdiction over Pre-Petition State Law Claims

There were two important differences in the facts of these cases for purposes of the subject matter jurisdiction issue. First, in the IT Group case, the confirmed plan had a specific provision assigning various causes of action to the IT Litigation Trust. 2005 WL 3050611 at *6. Among the list of claims assigned to the plaintiff trust were '[a]ny claims for acts or omissions of [the IT Group's] ' present or former officers, directors, insiders and accountants.' Id. The specific civil action itself, which already had been filed by the creditors committee at that time, was not mentioned in the plan by name. Id. In contrast, the Insilco plan contained no such specific provision. 330 B.R. at 517. Rather, in addition to a general retention of jurisdiction provision purporting to retain for the Bankruptcy Court 'exclusive jurisdiction' over any matter arising under the Bankruptcy Code, arising in or related to the Chapter 11 cases and the plan, the Insilco plan only had a general provision creating a Creditor's Trust and transferring to the Creditor's Trust the responsibility of filing and prosecuting all actions, causes of action, suits, and rights of actions that were held by or in favor of any of the Debtors or their estates. Id. Second, the IT Group case was commenced pre-confirmation by a creditors' committee and continued post-confirmation by a litigation trust, whereas Insilco was commenced in the first instance by a post-confirmation litigation trust. IT Group, 2005 WL 3050611 at *5; Insilco, 330 B.R. at 517.

Subject Matter Jurisdiction Decisions

As noted above, the IT Group and Insilco opinions reached different results on post-confirmation subject matter jurisdiction. Each opinion relied heavily on the Third Circuit's Resorts International decision for its discussion on whether 'related to' subject matter jurisdiction existed over the non-core state law claims. See generally, IT Group, 2005 WL 3050611 at *5-7; Insilco, 330 B.R. at 519-25.

The Insilco court began its analysis by looking to the plan's retention of jurisdiction provision. 330 B.R. at 518. While the court did not explicitly so state, apparently it concluded that the plan did purport to retain jurisdiction over the claims asserted in the complaint. However, it held that 'parties cannot 'write their own jurisdictional ticket' and a confirmation order cannot confer jurisdiction upon a bankruptcy court unless jurisdiction exists pursuant to 28 U.S.C. ' 1334 or 28 U.S.C. ' 157.' Id. at 519 (citing Resorts Int'l, 372 F.3d at 161). Therefore, according to the Insilco court, '[t]he first inquiry with respect to the claims asserted in the Amended Complaint is whether they are core matters.' Id. (If a plan does not purport to retain jurisdiction, however, theoretically one might argue that the 'first inquiry' should be whether jurisdiction ought to remain with the Bankruptcy Court in the absence of such a provision even if it could have asserted jurisdiction with such a provision. Thus, retention of jurisdiction clauses likely have some continued importance.)

Following the test articulated by the Third Circuit Court of Appeals in Halper v. Halper, 164 F.3d 830 (3d. Cir. 1999), the Insilco court determined that it had jurisdiction over the core claims of preference, fraudulent transfer and equitable subordination. Id. at 519-20. The Halper test provides:

'To determine whether a proceeding is a 'core' proceeding, courts of [the Third] Circuit must consult two sources. First, a court must consult [28 U.S.C.] ' 157(b). Although ' 157(b) does not precisely define 'core' proceedings, it nonetheless provides an illustrative list of proceedings that may be considered 'core.' [citation omitted] Second, the court must apply this court's test for a 'core' proceeding. Under that test, 'a proceeding is core 1) if it invokes a substantive right provided by title 11, or 2) if it is 'a proceeding, that by its nature, could arise only in the context of a bankruptcy case.' Halper, 164 F.3d 830, 836 (citation omitted). The Liquidating Trustee argued that the deepening insolvency and unjust enrichment claims were also core proceedings under the 'catch all' provisions of 28 U.S.C. ' 157(b)(2)(A) and (O). Insilco, 330 B.R. at 521. The court applied the Halper test and concluded that these claims were not core proceedings because neither claim invoked a substantive right provided by title 11, nor could either claim arise only in the context of a bankruptcy case. Id. at 521-22. (The state law pre-petition claims raised in IT Group were conceded to be non-core and therefore the Halper test was not implicated in IT Group).

The Insilco court then sought to determine whether there was 'related to' subject matter jurisdiction over the remaining claims. Id. at 522. The plaintiff/Liquidating Trustee argued that the close nexus test enunciated in Resorts International was met 'because the Plan specifically created the Creditor Trust and granted the Creditor Trust the responsibility to file, prosecute, and settle the 'Rights of Action,' thereby rendering [the] proceeding necessary in order to administer the Plan.' Id. at 523. Moreover, the Liquidating Trustee argued that the Creditor Trust's causes of action in Resorts International first arose post-confirmation, whereas the causes of action in Insilco arose pre-petition and were assigned to the creditor trust pursuant to the plan of liquidation. Id. at 523 (The claim at issue in Resorts International was a malpractice claim against professionals retained by the liquidation trust. 372 F.3d 154, 156). The Bankruptcy Court rejected this distinction. Insilco, 330 B.R. at 525. The court found that the pursuit of these non-core claims did not require interpretation of any plan provision. Id. at 525-26. Moreover, the court stated that the plan and disclosure statement did not specifically identify these claims as an asset to be liquidated and distributed to creditors, and failed to provide notice to creditors as to the importance of the litigation when voting on the plan. Id. at 526. Therefore, no close nexus to the plan was present to provide jurisdiction over the claims. Id.

In contrast, the IT Group decision by the Delaware District Court found the requisite close nexus between the state law claims and the bankruptcy and concluded that such claims are properly within the 'related to' jurisdiction granted under 28 U.S.C. ' 1334. 2005 WL 3050611 at *7. Two arguments were raised by the defendants for dismissal based on lack of subject matter jurisdiction; both of which were rejected. Id. at *6-7.

First, the IT Group defendants argued that because the IT Group estate no longer existed post-confirmation, the suit can have no effect on the estate. Id. at *6. Further, they argued that 'resolving the state law claims requires no construction, interpretation, or implementation of the plan.' Id. According to the defendants the 'only connection to the bankruptcy 'is that a recovery by the plaintiff might increase the assets of the Litigation Trust and its beneficiaries,' and that connection, on its own, is insufficient to support 'related to' jurisdiction.' Id.

The IT Group court rejected this reasoning as an 'overstatement' of the Third Circuit's Resorts International opinion. IT Group, 2005 WL 3050611 at *6. The mere fact that the estate no longer exists is not determinative according to the Court as the ”close nexus' test was formulated to address jurisdiction over claims arising post-confirmation ' ' Id. Further, unlike the malpractice claim in Resorts International, which arose 7 years after confirmation, the IT Group claims arose pre-petition and 'the losses claimed by Plaintiff on behalf of unsecured creditors are logically connected to the IT Group insolvency and subsequent bankruptcy.' Id. Moreover, this type of cause of action was specifically assigned to the Litigation Trust by the IT Group plan. Id. 'The assignment in a confirmed plan of a pre-petition cause of action could well establish the close nexus to the bankruptcy plan or a proceeding which the Third Circuit requires.' (citations omitted). Id. According to the court, 'resolving Plaintiff's state law claims may not require construction or interpretation of the plan, [however,] this proceeding 'plainly serves the plan through implementation, consummation, and execution which typify many post-confirmation matters.” Id. The state law claims fell within the categories of claims assigned to the Litigation Trust by the plan, and their pursuit was therefore contemplated by the plan itself. Thus, the Court found related to jurisdiction over the state law claims. Id. at *7.

Thus, while certainly two key facts distinguished IT Group from Insilco (the inclusion of a more specific Plan provision retaining jurisdiction in IT Group and the fact that IT Group was commenced pre-confirmation), in large measure these cases simply disagree with one another. Moreover, IT Group, written less than 2 months after Insilco, neither cites nor attempts to distinguish Insilco.

Supplemental Jurisdiction

Insilco also is noteworthy because it dismissed pre-petition non-bankruptcy law claims notwithstanding that the complaint also joined, and the court did not dismiss, core allegations of preference, fraudulent transfer and equitable subordination. 330 B.R. at 517. While the opinion is silent on the issue, it appears that either the court assumed that the Third Circuit Court of Appeals would follow the line of split authority which holds that bankruptcy courts, unlike federal district courts, lack authority to exercise 'pendent' or 'supplemental' jurisdiction, or that this would be an inappropriate case to exercise such jurisdiction. See, eg, Adams v. Prudential Sec, Inc. (In re Found. For New Era Philanthropy), 201 B.R. 382, 298 (Bankr. E.D. Pa. 1996). 'Supplemental jurisdiction allows federal [district] courts to hear and decide state-law claims along with federal-law claims when they 'are so related to claims in that action within such original jurisdiction that they form part of the same case or controversy.” Wis. Dep't. of Corr., et al. v. Schacht, 524 U.S. 381, 387 (1998) (quoting 28 U.S.C. ' 1367(a)). The Third Circuit, the Delaware District Court and the Delaware Bankruptcy Court have not issued a reported opinion on this subject to date. Interestingly, the IT Group opinion recognized this issue but noted that because there was subject matter jurisdiction over even the state law claims, there was no need for the Court to consider the parties' arguments on supplemental jurisdiction based upon the core avoidance counts. 2005 WL 3050611 at *7.

Next month, we discuss possible Implications of Insilco and IT Group on plan restructuring.

Two recent bankruptcy opinions out of the Delaware Court, IT Litigation Trust v. D'Aniella, et al. (In re: IT Group, Inc., et al.), ___ B.R. ___, 2005 WL 3050611 (D. Del. Nov. 15, 2005) and Shandler v. DLJ Merchant Banking, Inc., et al. (In re Insilco Technologies, Inc.), 330 B.R. 512 (Bankr. D. Del. 2005), each of which addresses post-confirmation bankruptcy court subject matter jurisdiction over state law causes of action, have potentially significant implications on both litigation in the Delaware Bankruptcy Court and plan structure for Chapter 11 debtors. In the IT Group opinion, the Delaware District Court, sitting as a trial court, held that it did have subject matter jurisdiction over pre-petition waste of corporate asset and breach of fiduciary duty claims based exclusively on Delaware state law, which were asserted originally by the Official Committee of Unsecured Creditors and post-confirmation by a litigation trust established by a Chapter 11 plan to pursue causes of action. 2005 WL 3050611 at *7. In contrast, the Insilco opinion held that the Bankruptcy Court lacked subject matter jurisdiction over pre-petition state law unjust enrichment and deepening insolvency causes of action commenced post-confirmation by a litigation trust authorized generally to bring such causes of action under a plan of liquidation. 330 B.R. at 526. In each opinion, the courts interpreted last year's decision by the Third Circuit Court of Appeals in Binder v. Price Waterhouse & Co., LLP (In re Resorts Int'l, Inc.), 372 F.3d, 154 (3d Cir. 2004), which held that 'related to' jurisdiction is greatly diminished post-confirmation and limited to matters in which there is a 'close nexus' to the bankruptcy plan or a proceeding. The different results reached in these cases illustrate the importance of a properly drafted Chapter 11 plan in retaining subject matter jurisdiction over important state law causes of action.

Factual Background of IT Group and Insilco

For purposes of this article, the basic facts of each case are similar. Both cases involved core and non-core causes of action asserted by trusts established pursuant to confirmed liquidating Chapter 11 plans to prosecute litigation. IT Group, 2005 WL 3050611 at *5-6; Insilco, 330 B.R. at 517. The core allegations prosecuted by the trusts in both cases involved avoidable preference and fraudulent transfer claims. IT Group, 2005 WL 3050611 at *1; Insilco, 330 B.R. at 517. Each case also involved non-core, state law claims: Insilco raising pre-petition claims of fraud, professional malpractice, unjust enrichment, deepening insolvency, breach of fiduciary duty, aiding and abetting breach of fiduciary duty and abuse of control and IT Group raising pre-petition claims of breach of fiduciary duty, corporate waste and unlawful payment of dividends. IT Group, 2005 WL 3050611 at *1; Insilco, 330 B.R. at 517. (Note: The claims raised in the IT Group complaint were based, in part, upon allegations that certain failures of the defendants 'caused or deepened (the IT Group's) insolvency, and sealed its financial doom.' Whether the 'deepening insolvency' allegation is a separate cause of action (as alleged in Insilco) or a theory of damages or a basis to allege an independent cause of action such as a breach of fiduciary duty (as in IT Group), continues to be the subject of debate. See, eg, In re Global Service Corp., LLC, 316 B.R. 451 (Bankr. S.D. N. Y. 2004); Willet, S: The Shallows of Deepening Insolvency. 60 The Business Lawyer No. 2 (Feb. 2005).) Also, in each case, the defendants filed motions to dismiss asserting the court lacked subject matter jurisdiction over the non-core, pre-petition, state law causes of action. IT Group, 2005 WL 3050611 at *1; Insilco, 330 B.R. at 518.

There were two important differences in the facts of these cases for purposes of the subject matter jurisdiction issue. First, in the IT Group case, the confirmed plan had a specific provision assigning various causes of action to the IT Litigation Trust. 2005 WL 3050611 at *6. Among the list of claims assigned to the plaintiff trust were '[a]ny claims for acts or omissions of [the IT Group's] ' present or former officers, directors, insiders and accountants.' Id. The specific civil action itself, which already had been filed by the creditors committee at that time, was not mentioned in the plan by name. Id. In contrast, the Insilco plan contained no such specific provision. 330 B.R. at 517. Rather, in addition to a general retention of jurisdiction provision purporting to retain for the Bankruptcy Court 'exclusive jurisdiction' over any matter arising under the Bankruptcy Code, arising in or related to the Chapter 11 cases and the plan, the Insilco plan only had a general provision creating a Creditor's Trust and transferring to the Creditor's Trust the responsibility of filing and prosecuting all actions, causes of action, suits, and rights of actions that were held by or in favor of any of the Debtors or their estates. Id. Second, the IT Group case was commenced pre-confirmation by a creditors' committee and continued post-confirmation by a litigation trust, whereas Insilco was commenced in the first instance by a post-confirmation litigation trust. IT Group, 2005 WL 3050611 at *5; Insilco, 330 B.R. at 517.

Subject Matter Jurisdiction Decisions

As noted above, the IT Group and Insilco opinions reached different results on post-confirmation subject matter jurisdiction. Each opinion relied heavily on the Third Circuit's Resorts International decision for its discussion on whether 'related to' subject matter jurisdiction existed over the non-core state law claims. See generally, IT Group, 2005 WL 3050611 at *5-7; Insilco, 330 B.R. at 519-25.

The Insilco court began its analysis by looking to the plan's retention of jurisdiction provision. 330 B.R. at 518. While the court did not explicitly so state, apparently it concluded that the plan did purport to retain jurisdiction over the claims asserted in the complaint. However, it held that 'parties cannot 'write their own jurisdictional ticket' and a confirmation order cannot confer jurisdiction upon a bankruptcy court unless jurisdiction exists pursuant to 28 U.S.C. ' 1334 or 28 U.S.C. ' 157.' Id. at 519 (citing Resorts Int'l, 372 F.3d at 161). Therefore, according to the Insilco court, '[t]he first inquiry with respect to the claims asserted in the Amended Complaint is whether they are core matters.' Id. (If a plan does not purport to retain jurisdiction, however, theoretically one might argue that the 'first inquiry' should be whether jurisdiction ought to remain with the Bankruptcy Court in the absence of such a provision even if it could have asserted jurisdiction with such a provision. Thus, retention of jurisdiction clauses likely have some continued importance.)

Following the test articulated by the Third Circuit Court of Appeals in Halper v. Halper , 164 F.3d 830 (3d. Cir. 1999), the Insilco court determined that it had jurisdiction over the core claims of preference, fraudulent transfer and equitable subordination. Id. at 519-20. The Halper test provides:

'To determine whether a proceeding is a 'core' proceeding, courts of [the Third] Circuit must consult two sources. First, a court must consult [28 U.S.C.] ' 157(b). Although ' 157(b) does not precisely define 'core' proceedings, it nonetheless provides an illustrative list of proceedings that may be considered 'core.' [citation omitted] Second, the court must apply this court's test for a 'core' proceeding. Under that test, 'a proceeding is core 1) if it invokes a substantive right provided by title 11, or 2) if it is 'a proceeding, that by its nature, could arise only in the context of a bankruptcy case.' Halper, 164 F.3d 830, 836 (citation omitted). The Liquidating Trustee argued that the deepening insolvency and unjust enrichment claims were also core proceedings under the 'catch all' provisions of 28 U.S.C. ' 157(b)(2)(A) and (O). Insilco, 330 B.R. at 521. The court applied the Halper test and concluded that these claims were not core proceedings because neither claim invoked a substantive right provided by title 11, nor could either claim arise only in the context of a bankruptcy case. Id. at 521-22. (The state law pre-petition claims raised in IT Group were conceded to be non-core and therefore the Halper test was not implicated in IT Group).

The Insilco court then sought to determine whether there was 'related to' subject matter jurisdiction over the remaining claims. Id. at 522. The plaintiff/Liquidating Trustee argued that the close nexus test enunciated in Resorts International was met 'because the Plan specifically created the Creditor Trust and granted the Creditor Trust the responsibility to file, prosecute, and settle the 'Rights of Action,' thereby rendering [the] proceeding necessary in order to administer the Plan.' Id. at 523. Moreover, the Liquidating Trustee argued that the Creditor Trust's causes of action in Resorts International first arose post-confirmation, whereas the causes of action in Insilco arose pre-petition and were assigned to the creditor trust pursuant to the plan of liquidation. Id. at 523 (The claim at issue in Resorts International was a malpractice claim against professionals retained by the liquidation trust. 372 F.3d 154, 156). The Bankruptcy Court rejected this distinction. Insilco, 330 B.R. at 525. The court found that the pursuit of these non-core claims did not require interpretation of any plan provision. Id. at 525-26. Moreover, the court stated that the plan and disclosure statement did not specifically identify these claims as an asset to be liquidated and distributed to creditors, and failed to provide notice to creditors as to the importance of the litigation when voting on the plan. Id. at 526. Therefore, no close nexus to the plan was present to provide jurisdiction over the claims. Id.

In contrast, the IT Group decision by the Delaware District Court found the requisite close nexus between the state law claims and the bankruptcy and concluded that such claims are properly within the 'related to' jurisdiction granted under 28 U.S.C. ' 1334. 2005 WL 3050611 at *7. Two arguments were raised by the defendants for dismissal based on lack of subject matter jurisdiction; both of which were rejected. Id. at *6-7.

First, the IT Group defendants argued that because the IT Group estate no longer existed post-confirmation, the suit can have no effect on the estate. Id. at *6. Further, they argued that 'resolving the state law claims requires no construction, interpretation, or implementation of the plan.' Id. According to the defendants the 'only connection to the bankruptcy 'is that a recovery by the plaintiff might increase the assets of the Litigation Trust and its beneficiaries,' and that connection, on its own, is insufficient to support 'related to' jurisdiction.' Id.

The IT Group court rejected this reasoning as an 'overstatement' of the Third Circuit's Resorts International opinion. IT Group, 2005 WL 3050611 at *6. The mere fact that the estate no longer exists is not determinative according to the Court as the ”close nexus' test was formulated to address jurisdiction over claims arising post-confirmation ' ' Id. Further, unlike the malpractice claim in Resorts International, which arose 7 years after confirmation, the IT Group claims arose pre-petition and 'the losses claimed by Plaintiff on behalf of unsecured creditors are logically connected to the IT Group insolvency and subsequent bankruptcy.' Id. Moreover, this type of cause of action was specifically assigned to the Litigation Trust by the IT Group plan. Id. 'The assignment in a confirmed plan of a pre-petition cause of action could well establish the close nexus to the bankruptcy plan or a proceeding which the Third Circuit requires.' (citations omitted). Id. According to the court, 'resolving Plaintiff's state law claims may not require construction or interpretation of the plan, [however,] this proceeding 'plainly serves the plan through implementation, consummation, and execution which typify many post-confirmation matters.” Id. The state law claims fell within the categories of claims assigned to the Litigation Trust by the plan, and their pursuit was therefore contemplated by the plan itself. Thus, the Court found related to jurisdiction over the state law claims. Id. at *7.

Thus, while certainly two key facts distinguished IT Group from Insilco (the inclusion of a more specific Plan provision retaining jurisdiction in IT Group and the fact that IT Group was commenced pre-confirmation), in large measure these cases simply disagree with one another. Moreover, IT Group, written less than 2 months after Insilco, neither cites nor attempts to distinguish Insilco.

Supplemental Jurisdiction

Insilco also is noteworthy because it dismissed pre-petition non-bankruptcy law claims notwithstanding that the complaint also joined, and the court did not dismiss, core allegations of preference, fraudulent transfer and equitable subordination. 330 B.R. at 517. While the opinion is silent on the issue, it appears that either the court assumed that the Third Circuit Court of Appeals would follow the line of split authority which holds that bankruptcy courts, unlike federal district courts, lack authority to exercise 'pendent' or 'supplemental' jurisdiction, or that this would be an inappropriate case to exercise such jurisdiction. See, eg, Adams v. Prudential Sec, Inc. (In re Found. For New Era Philanthropy), 201 B.R. 382, 298 (Bankr. E.D. Pa. 1996). 'Supplemental jurisdiction allows federal [district] courts to hear and decide state-law claims along with federal-law claims when they 'are so related to claims in that action within such original jurisdiction that they form part of the same case or controversy.” Wis. Dep't. of Corr., et al. v. Schacht, 524 U.S. 381, 387 (1998) (quoting 28 U.S.C. ' 1367(a)). The Third Circuit, the Delaware District Court and the Delaware Bankruptcy Court have not issued a reported opinion on this subject to date. Interestingly, the IT Group opinion recognized this issue but noted that because there was subject matter jurisdiction over even the state law claims, there was no need for the Court to consider the parties' arguments on supplemental jurisdiction based upon the core avoidance counts. 2005 WL 3050611 at *7.

Next month, we discuss possible Implications of Insilco and IT Group on plan restructuring.