Enjoining Actions Against Non-Debtors

Under section 105(a), a bankruptcy court “may issue any order, process, or judgment that is necessary or appropriate to carry out” the provisions of the Bankruptcy Code. Courts widely agree this grants them power to enjoin actions against a non-debtor that threaten the bankrupt's estate.

When moved to enjoin such actions against a non-debtor, many courts have applied a slight variation of the four-pronged standard for preliminary injunctions. See, e.g., Solidus Networks, Inc. v. Excel Innovations, Inc. (In re Excel Innovations, Inc. , 502 F.3d 1086, 1094 (9th Cir. 2007) (citing cases from the U.S. Courts of Appeal for the Fourth, Fifth and Sixth Circuits that apply the preliminary injunction standard, or a slight variation, to injunctions against non-debtors under section 105(a)).

To secure a preliminary injunction, a moving party generally must show: 1) a strong likelihood of success on the merits; 2) the possibility of irreparable injury if the preliminary injunction is not granted; 3) a balance of hardships favoring the moving party; and 4) advancement of the public interest. The Excel court and many others have modified the first prong for the bankruptcy context ' requiring the moving party to instead show a reasonable likelihood of a successful reorganization ' but have left the other three prongs unchanged. Id. at 1095-96.

Before Caesars, the Seventh Circuit had applied a somewhat different standard in such situations. Like its sister courts, the Seventh Circuit required debtors to show a reasonable likelihood of a successful reorganization and that the injunction would serve the public interest, two prongs pulled from the standard for preliminary injunctions. But unlike the circuit courts that apply the full four-prong test, the Seventh Circuit did not require a showing of irreparable harm and was ambiguous about the need for a balancing of hardships.

Despite the absence of two prongs, the Seventh Circuit was not particularly debtor-friendly when it came to staying actions against a non-debtor. Before Caesars , the Seventh Circuit barred staying such an action unless the action was also “related to” the debtor's bankruptcy case. Fisher v. Apostolou, 155 F.3d 876, 882 (7th Cir. 1998). The meaning of this requirement was left somewhat unclear. The Seventh Circuit, however, had only found sufficient relatedness when an action against a non-debtor involved the “same acts” as a claim pursued by a debtor. See id. at 883. This pre- Caesars standard likely deterred many debtors in the Seventh Circuit from seeking to enjoin actions against non-debtors. The apparent difficulty of showing an action against a non-debtor was sufficiently related to the bankruptcy case seemed to set a high bar for debtors to hurdle.

Likewise, the four-part standard used by other circuit courts is also difficult for debtors to meet. The standard is recognized by bankruptcy courts as “intensely fact driven.” See Saxby's Coffee Worldwide, LLC v. Larson (In re Saxby's Coffee Worldwide, LLC), 440 B.R. 369, 380 (Bankr. E.D. Pa. 2009). Altogether, the four prongs place a heavy burden on a debtor to marshal facts about itself as well as about the party whose action the debtor seeks to enjoin. The demanding nature of this standard is purposeful as it helps ensure injunctions against non-debtors under 11 U.S.C. ' 105(a) are not granted lightly. See In re Excel, 502 F.3d at 1095.

The Caesars Case

Initially, the bankruptcy court in Caesars applied the Seventh Circuit's apparent pre- Caesars injunction standard ' consisting of two preliminary injunction prongs and requiring sufficient relatedness ' and denied the debtor's motion. Caesars involved the bankruptcy of Caesars Entertainment Operating Company (CEOC) and various actions against CEOC's principal owner, Caesars Entertainment Corp. (CEC). In 2005, CEOC began borrowing nearly $4.6 billion to finance its operations, issuing notes guaranteed by CEC. The 2008 financial crisis and increasing competition in the gaming industry, however, subsequently hindered CEOC's ability to service the notes. As CEOC's financial situation declined, CEC sold various CEOC assets, some of which CEC itself acquired. CEC also tried to terminate its guaranty obligations under CEOC's notes.

The noteholders quickly began filing suits against CEC in state and federal courts challenging the termination of the guaranties. CEOC then filed for bankruptcy in the Northern District of Illinois and brought an avoidance action against CEC, alleging the transfers of CEOC's assets to CEC were fraudulent.

CEOC also moved enjoin the guaranty suits against CEC, claiming the suits threatened to thwart its restructuring effort, which depended on a substantial contribution from CEC in settlement of the avoidance action. CEOC sought the injunction so an examiner could independently assess its avoidance claims against CEC, in the hope that such report would help the parties negotiate a settlement that provided for CEOC's reorganization.

The bankruptcy court denied CEOC's motion to enjoin the guaranty suits, concluding Seventh Circuit precedent barred an injunction under section 105(a) unless the noteholders' claims against CEC were against “the same assets in possession of the same defendants, and ' [arose] out of the same acts” as CEOC's claims against CEC. In re Caesars Entm't Operating Co., Inc., 533 B.R. 714, 730 (Bankr. N.D. Ill.). The district court affirmed the bankruptcy court's decision. In re Caesars Entm't Operating Co., Inc., No. 15 C 6504, 2015 WL 5920882, at *7 (N.D. Ill. Oct. 6, 2015).

The Seventh Circuit, however, reversed and remanded, stating that the lower courts' reasoning involved a “cramped interpretation of section 105(a).” Caesars, 808 F.3d at 1188. Instead of focusing on the statute's limitations, the Seventh Circuit highlighted that section 105(a) grants “extensive equitable powers” and merely requires that injunctions, be “appropriate to carry out the provisions” of the Bankruptcy Code. Id. at 1189. The court explained that enjoining an action against a non-debtor under section 105(a) is appropriate if: 1) the injunction is likely to enhance the prospect of resolving the disputes in the bankruptcy case; and 2) the denial of the injunction would endanger the success of the bankruptcy proceedings. Id. at 1188-89.

On remand, the bankruptcy court held that these two prongs were met for the two creditors whose actions were set for trial before the examiner could finish his investigation and publish his report. As a result, the bankruptcy court entered an order enjoining the two actions against CEC until the earlier of the 60th day following the issuance of the examiner's report or May 9, 2016. In re Caesars Entm't Operating Co., No. 15-00149 (Bankr. N.D. Ill. Feb. 26, 2016) (Order Granting in Part and Continuing in Part Debtors' Mot. to Stay or in the Alternative for Inj. Relief).

On March 15, 2016, the examiner issued his report, wherein he concluded that CEC could be liable to CEOC's estate by as much as $5 billion.

In April 2016, the district court judge who was originally set to hear the enjoined actions against CEC retired and the judge who took over the actions immediately postponed their trial dates to August 2016. This further delay proved beneficial for CEOC, which has until July to propose a reorganization plan. Thus, shortly before the injunction expired, CEOC informed the bankruptcy court at a hearing in early May 2016 that it did not plan to request an extension of the injunction.

An Open Door for Debtors

Prior to Caesars, a debtor had little chance of enjoining lawsuits against third parties except under very limited circumstances. Consequently, a debtor (or even an entity on the verge of bankruptcy) often had little, if any, negotiating leverage with entities who had filed, or were likely to soon file, actions against non-debtor third parties, even where those lawsuits interfered with the debtor's ability to achieve its restructuring objectives. Absent the ability to enjoin such actions, the debtor (or entity nearing bankruptcy) had little ability to even bring the entity with a claim against such a non-debtor third-party to the negotiating table.

Caesars changes this dynamic, by lowering the standard for a debtor to obtain a stay under section 105(a) of the continuation of lawsuits against non-debtors. By doing so, Caesars has given debtors an additional, and highly valuable, tool for achieving their restructuring objectives.

Armed with the ability to enjoin not only actions against itself, but actions against non-debtor third parties that might interfere with their restructuring objectives, debtors now have significantly improved negotiating leverage. Even without having to threaten to take or forebear from taking any action in a bankruptcy case, debtors will benefit from the realization on the part of their creditors and third parties that debtors can more easily obtain a stay of lawsuits against non-debtors.

In some circumstances, this improved negotiating leverage may prove so valuable as to enable debtors to avoid having to file for bankruptcy altogether.

Similarly, after filing their bankruptcy petitions, debtors now have a stronger weapon to bring third parties to the negotiating table that in the past would have thumbed their nose at the debtor. Once brought to the negotiating table, debtors can use the threat of an injunction to seek new or additional concessions from third parties having actions against non-debtors. Such concessions could be in an infinite number of forms ' including foregoing or postponing claims against the debtor or the non-debtor third party, pledging support for the debtor's reorganization plan, and agreeing to conduct business with the debtor on more favorable terms than otherwise.

Or, as in the case of Caesars, where the debtor has claims against a non-debtor and the stay of litigation against the non-debtor would enhance creditor recoveries in the debtor's bankruptcy, the ability to enjoin actions against non-debtor third parties might be enough to cause the entities prosecuting such claims to conclude that such an injunction might result in it losing the race to obtaining a judgment against the non-debtor third party and thus its interests would be better advanced by engaging in settlement discussions.

Accordingly, in cases in which an entity has filed, or is likely to file, a lawsuit against a non-debtor third party that interferes with the debtor's ability to achieve its restructuring objectives, the authors strongly encourage debtors to consider seeking an injunction of the litigation against such non-debtors or at least factor that possibility into its negotiation strategy.

Similarly, from the creditor perspective, creditors would be wise to consider the increased possibility that, should they refuse to take a seat at the negotiation table, a debtor might not only obtain the entry of an order enjoining the creditor's collection lawsuit, but such injunction might result later result in a far lower recovery by the time they are permitted to proceed with their lawsuit.

Therefore, the authors encourage debtors and creditors alike to account for the lowered evidentiary standard for obtaining a non-debtor stay in the wake of Caesars when evaluating their respective negotiating positions and developing their strategic plans.

Todd L. Padnos, a member of this newsletter's Board of Editors, is a partner and Matt Klinger is an associate in the San Francisco office of Sheppard Mullin Richter & Hampton LLP. They can be reached, respectively, at [email protected] and [email protected].