The Queen Is Dead, Long Live the Queen?

In Queenie, Heavenly Fabrics Inc., Marc Gardner (Gardner), the owner of Queenie Ltd. (Queenie) and Joseph Heaven (collectively, Counterclaim Defendants) sued Nygard Ltd. (Nygard) for patent infringement. Nygard countersued for tortious interference. The district court found that the Counterclaim Defendants were liable for tortious interference and the Counterclaim Defendants appealed to the Second Circuit. During the pendency of the appeal, Gardner filed for personal bankruptcy. The Second Circuit found that the stay applied to “Queenie [Gardner's wholly owned company that was also a defendant] because it is wholly owned by Gardner, and adjudication of a claim against the corporation will have an immediate adverse economic impact on Gardner.” Id. at 288. The Second Circuit's rationale appears to be that § 362 stays actions against a debtor's related entity to protect a debtor from immediate adverse economic impact.

In light of the departure from precedent and the dramatic extension of the stay, Queenie contained only a brief analysis of its rationale. Notably, Queenie was a departure from the previous Second Circuit precedent that the protections of the automatic stay did not extend to non-debtor subsidiaries. See, e.g., Feldman v. Beck Indus., Inc., 479 F.2d 410, 416 (2d Cir.1973) (“mere financial interest of a bankrupt estate in the outcome of the litigation pending in state courts does not authorize the issuance of an injunction against such prosecution”). The rationale is quite simple: If a subsidiary seeks the benefits of the automatic stay, it is required to the have the obligations of a debtor.

Despite being bound by Queenie, many lower courts in the Second Circuit are wont to treat the holding as an inadvertence, distinguishing Queenie to oblivion through manufactured factors. Despite these extremely narrow applications, the lower courts are rarely, if ever, reversed. However, 10 years after Queenie was decided, the Second Circuit provided a reminder that quelled rumors of Queenie's demise. In In re Residential Capital, the Second Circuit remanded a case because “the district court denied application of Section 362(a)'s automatic stay to the non-debtor entities as a categorical matter, without factual findings as to whether the lawsuit against those entities would have had 'immediate adverse economic consequence[s]' on ResCap's estate.” In re Residential Capital, LLC, 529 Fed.Appx. 69, 71 (2d Cir. 2013) (quoting Queenie). Not surprisingly, on remand, the district court found that the extension of the stay was not warranted under Queenie. Residential Capital, LLC v. Federal Housing Finance Agency, 2013 WL 4056195, at *3 (S.D.N.Y. 2013). By requiring courts to apply Queenie's immediate adverse economic consequence, the Second Circuit failed to calm the controversy surrounding it. Following that decision, a split developed among the district courts in the Eastern District of New York regarding Queenie's application.

The Split

In Queenie, the only requirement articulated by the Second Circuit was the need for immediate adverse economic impact on the debtor. Queenie did not consider whether the property was necessary for reorganization, the extent of the adverse economic impact. or the chapter the debtor filed.

Consistent with Queenie's language, Ng v. Adler (Adler II) expansively interpreted Queenie. 518 B.R. 228, 247 (E.D.N.Y. 2014) (affirming In re Adler, 494 B.R. 43 (Bankr. E.D.N.Y. 2013) (Adler I)).
In Adler I, the plaintiff filed suit against an individual and five corporations in April 2004. In midst of the litigation, the individual filed a Chapter 7 bankruptcy petition. As a result, the individual debtor was dropped from the state court suit. In September 2005, the state court (State Court) entered a judgment against the corporations in the amount of $2,024,345.57. Approximately eight years later, the bankruptcy court pierced the veil between the debtor and corporation. The court concluded that Queenie's “'immediate adverse economic consequences' test had been triggered prepetition, and the automatic stay protected any non-debtor alter ego corporation from further judicial action.” Further, “the Plaintiffs cannot claim to have been unaware of the Debtor's potential status as an alter ego … their state court complaint [sought] to pierce the Corporations' veils and render the Debtor liable.” Thus, Adler I concluded that Queenie required it to sua sponte declare the State Court decision and judgment void ab initio.

On appeal, the defendant argued, among other things, that Adler I erred, as it improperly applied Queenie because: 1) the debtor was in a Chapter 7 liquidation and not a reorganization; and 2) the bankruptcy court failed to adequately analyze the extent of the adverse economic consequences.

In affirming the lower court, Adler II held that: 1) “Queenie simply requires an immediate adverse economic impact on the debtor's estate, without regard to whether the debtor filed for bankruptcy under Chapter 11 or any other chapter”; and 2) “The Second Circuit neither defined 'immediate' nor provided any detailed consideration of the consequences on the debtor's estate. Rather, the relationship between the parties was sufficient to meet the standard [and as such] the stay should be extended to [the debtor's] wholly owned corporation.” Id. at 249. Thus, Adler II concluded that Queenie applies to any (regardless of the chapter filed) debtor's wholly owned corporation.

In contrast, Pavers & Road Builders Dist. Council Welfare Fund v. Core Contracting of N.Y., LLC, noted that “Whatever may be said for [Queenie], it has no application here … ” 536 B.R. 48, 51 (E.D.N.Y. 2015) (denying extension of the Automatic Stay to non-debtor entities based on theories of alter ego). It noted that the “automatic stay is automatic as applied to a debtor because that is what the statute says. As to non-debtors, it is relief that is available, but it is not automatic.” Id. at 53. This is consistent with prior jurisprudence. “Most, if not all courts consider the extension of the automatic stay under Code Section 362(a) to a nondebtor to be extraordinary relief … this Court has found that when an extension is allowed it is in circumstances where the debtor is a corporation and the nondebtor is an individual or related corporation deemed necessary for the reorganization … ” In re McCormick, 381 B.R. 594, 601 (Bankr. S.D.N.Y. 2008). See also, e.g., Reliant Energy Servs., 349 F.3d at 825–26; Favorito Elec., Inc., 2010 WL 985307 (E.D.N.Y. Mar. 15, 2010); In re Cheyenne Sales Co., No. 09–741, 2009 WL 1405015 (Bankr.N.D.W.Va. May 19, 2009).

Retroactive Application of The Automatic Stay: Piercing the Corporate Veil

Adler I retroactively extended the Automatic Stay to an alter ego and found the judgment was retroactively void ab initio. The retroactive extension of the Automatic Stay may well result in significant complexity. To apply the stay where it is alleged that a non-debtor is an alter ego requires a court finding that: 1) there is a piercing of the corporate veil; and 2) there is an immediate adverse effect on the estate. If it is determined post-petition that the automatic stay extends to a non-debtor entity as a pre-petition alter ego, then based on Adler I, they are void ab initio. This creates a twilight zone for plaintiffs prior to that determination because proceeding in a non-bankruptcy court risks any post-petition relief from the non-bankruptcy court being voided by an alter ego determination and also because a bankruptcy court would likely lack jurisdiction over non-debtor entities prior to piercing the veil

Pavers further differed from Adler I regarding the retroactive application of the automatic stay. Pavers argued that the retroactive application of the Automatic Stay, based on theories of alter ego, is unfair to parties whose prior efforts against a non-debtor entity would be invalidated by such an application. “[T]he Bankruptcy Court's dictum makes the automatic stay into a provision that can only be applied with the benefit of hindsight. It allows extensive litigation in the non-bankruptcy court, and then invalidates everything that occurred even though the debtor made no effort to stop it.” Pavers, 536 B.R., 51.

Lese Majeste: Limiting Queenie

It can be argued there are three primary factors mitigating against a broad interpretation of Queenie. These include:

1. The case law relied upon by Queenie. There is a tension between Queenie's broad language and the narrow precedent the Second Circuit relied upon. Queenie appears to apply to all property that is wholly owned by the Debtor, irrespective of whether it will impact a reorganization. Queenie did not discuss how immediate or the extent of the harm on his estate or, if it was necessary to the reorganization. In contrast, the precedent that the Circuit relied upon required “unusual circumstances” — generally associated with § 105 — to expand the automatic stay. See, e.g., A.H. Robins Co. v. Piccinin, 788 F.2d 994, 999 (4th Cir.1986) (“likelihood of success by the debtor. Appeared indisputable” and “hardships which would be suffered irreparably by the debtor and by its creditors”) and Johns-Manville Corp. v. Asbestos Litigation Group (In re Johns-Manville Corp.), 26 B.R. 420, 435-36 (Bankr.S.D.N.Y.1983) (prohibiting suits against insurer to “insure uniform treatment of all asbestos-related health claimants”). In these toxic tort cases, even without the benefit of § 105 or § 362, a court may have well entered an injunction staying litigation in other forum to insure fair treatment of all the claimants. See, e.g., A.H. Robins, 788 F.2d 994, 999. In contrast to the significant hurdles associated with these cases, Queenie appears to only require an immediate adverse economic impact on the Debtor.

2. The language of § 362. Queenie appears to ignore the plain language of the automatic stay of 11 U.S.C. § 362, which provides that “the automatic stay protects only the debtor, not non-debtor entities … . If the non-debtor entity wants that protection, it need only file its own petition.” Pavers, 536 B.R. 48, 51. Likewise, “immediate adverse economic consequences” is consistent with the equitable standard of § 105 and not automatic standard of § 362.

3. The portion of Queenie addressing the Automatic Stay is a side issue, at best, in a complex and exasperating case. Finally, the lower courts are likely influenced by the fact that Queenie's discussion of the Automatic Stay appears to be almost an afterthought and was not by any means the focus of the complex case. The Second Circuit was faced with “a choice between enforcing the forfeiture or burdening parties, witnesses, jurors, and the trial court with a retrial.” Queenie, 321 F.3d at, 283-84. Consistent with its prior actions, the Second Circuit found that the parties' briefing was of limited use, at best. Significantly, no party objected to the application of the automatic stay. Queenie, 321 F.3d at 287.

These three factors provide more than ample basis for lower courts to narrowly interpret Queenie under the rubric of § 105.

Conclusion

In Queenie, the Second Circuit appeared to broadly interpret the application of the automatic stay to include wholly owned non-debtor entities. As discussed, the majority of lower courts' narrower view can be reconciled with Queenie and, perhaps as a result, have generally not suffered reversal. In contrast, Adler I and Adler II's broad view is consistent with Queenie's language, and, as such, they cannot be consigned to a minority opinion. Adding to this confusion of 13 years, the Second Circuit has failed to rule definitively about the scope of the Queenie decision and when presented with the opportunity, it merely held that Queenie cannot being ignored and must be considered. Thus, creditors and debtors, especially in the EDNY, must be aware of the uncertainty regarding the scope of Queenie and consider it in their calculus.

Further, the possibility that an alter ego can be determined and the automatic stay can be voided retroactively can create a paralysis until the alter ego is determined. This is a very real concern based on the split in the District Court for the Eastern District of New York. However, as Pavers noted, “it is well established that non-bankruptcy courts have concurrent jurisdiction with the bankruptcy court to determine the scope of the automatic stay.” Pavers, 536 B.R., 51, citing In re Baldwin-United Corp. Litig., 765 F.2d 343 (2d Cir.1985). Thus, to avoid the risk of the retroactive application of the Automatic Stay to the non-Debtor entity, a plaintiff should ensure that the non-bankruptcy court make its implicit finding, that the automatic stay is not applicable to the non-debtor entity, explicit.

*****
Yitzhak Greenberg is of counsel with Bronstein, Gewirtz & Grossman, LLC, a litigation boutique in New York City. His practice is focused on all aspects of bankruptcy, including the representation of both debtors and creditors. He can be reached at [email protected].

The automatic stay of 11 U.S.C. § 362 is one of the most important principles of bankruptcy law. It provides crucial breathing space for the debtor to reorganize or liquidate, and avoids the piecemeal dismemberment of the estate's assets. Among other things, it stays “the commencement or continuation … of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title.” While the scope of the automatic stay's protection is broad, it is generally limited to a debtor.

However, in rare instances, courts have extended stay protection to non-debtors through 11 USC § 105. This is considered extraordinary relief reserved for unusual circumstances, and may be analogized to the inherent power of federal courts under their general equity powers. The high burden to grant this extraordinary equitable relief includes: 1) “danger of imminent, irreparable harm”; 2) “reasonable likelihood of a successful reorganization”; 3) “balancing the relative harm as between the debtor and the creditor”; and 4) “balancing of the public interest in successful bankruptcy reorganizations with competing societal interests.” In re SDNY 19 Mad Park, LLC, 2014 WL 4473873, at *3 (Bankr. S.D.N.Y. 2014).

In the seminal case of Queenie, Ltd. v. Nygard Intern. , 321 F.3d 282, 288 (2d Cir. 2003), the U.S. Court of Appeals for the Second Circuit broadly expanded the automatic stay to include a debtor's wholly owned subsidiary where the adjudication against the non-debtor would have an immediate adverse economic impact on the debtor: “The automatic stay can apply to non-debtors, but normally does so only when a claim against the non-debtor will have an immediate adverse economic consequence for the debtor's estate.” Id.

In Queenie, Heavenly Fabrics Inc., Marc Gardner (Gardner), the owner of Queenie Ltd. (Queenie) and Joseph Heaven (collectively, Counterclaim Defendants) sued Nygard Ltd. (Nygard) for patent infringement. Nygard countersued for tortious interference. The district court found that the Counterclaim Defendants were liable for tortious interference and the Counterclaim Defendants appealed to the Second Circuit. During the pendency of the appeal, Gardner filed for personal bankruptcy. The Second Circuit found that the stay applied to “Queenie [Gardner's wholly owned company that was also a defendant] because it is wholly owned by Gardner, and adjudication of a claim against the corporation will have an immediate adverse economic impact on Gardner.” Id. at 288. The Second Circuit's rationale appears to be that § 362 stays actions against a debtor's related entity to protect a debtor from immediate adverse economic impact.

In light of the departure from precedent and the dramatic extension of the stay, Queenie contained only a brief analysis of its rationale. Notably, Queenie was a departure from the previous Second Circuit precedent that the protections of the automatic stay did not extend to non-debtor subsidiaries. See , e.g. , Feldman v. Beck Indus., Inc. , 479 F.2d 410, 416 (2d Cir.1973) (“mere financial interest of a bankrupt estate in the outcome of the litigation pending in state courts does not authorize the issuance of an injunction against such prosecution”). The rationale is quite simple: If a subsidiary seeks the benefits of the automatic stay, it is required to the have the obligations of a debtor.

Despite being bound by Queenie, many lower courts in the Second Circuit are wont to treat the holding as an inadvertence, distinguishing Queenie to oblivion through manufactured factors. Despite these extremely narrow applications, the lower courts are rarely, if ever, reversed. However, 10 years after Queenie was decided, the Second Circuit provided a reminder that quelled rumors of Queenie's demise. In In re Residential Capital, the Second Circuit remanded a case because “the district court denied application of Section 362(a)'s automatic stay to the non-debtor entities as a categorical matter, without factual findings as to whether the lawsuit against those entities would have had 'immediate adverse economic consequence[s]' on ResCap's estate.” In re Residential Capital, LLC, 529 Fed.Appx. 69, 71 (2d Cir. 2013) (quoting Queenie). Not surprisingly, on remand, the district court found that the extension of the stay was not warranted under Queenie. Residential Capital, LLC v. Federal Housing Finance Agency, 2013 WL 4056195, at *3 (S.D.N.Y. 2013). By requiring courts to apply Queenie's immediate adverse economic consequence, the Second Circuit failed to calm the controversy surrounding it. Following that decision, a split developed among the district courts in the Eastern District of New York regarding Queenie's application.

The Split

In Queenie, the only requirement articulated by the Second Circuit was the need for immediate adverse economic impact on the debtor. Queenie did not consider whether the property was necessary for reorganization, the extent of the adverse economic impact. or the chapter the debtor filed.

Consistent with Queenie's language, Ng v. Adler (Adler II) expansively interpreted Queenie. 518 B.R. 228, 247 (E.D.N.Y. 2014) (affirming In re Adler, 494 B.R. 43 (Bankr. E.D.N.Y. 2013) (Adler I)).
In Adler I, the plaintiff filed suit against an individual and five corporations in April 2004. In midst of the litigation, the individual filed a Chapter 7 bankruptcy petition. As a result, the individual debtor was dropped from the state court suit. In September 2005, the state court (State Court) entered a judgment against the corporations in the amount of $2,024,345.57. Approximately eight years later, the bankruptcy court pierced the veil between the debtor and corporation. The court concluded that Queenie's “'immediate adverse economic consequences' test had been triggered prepetition, and the automatic stay protected any non-debtor alter ego corporation from further judicial action.” Further, “the Plaintiffs cannot claim to have been unaware of the Debtor's potential status as an alter ego … their state court complaint [sought] to pierce the Corporations' veils and render the Debtor liable.” Thus, Adler I concluded that Queenie required it to sua sponte declare the State Court decision and judgment void ab initio.

On appeal, the defendant argued, among other things, that Adler I erred, as it improperly applied Queenie because: 1) the debtor was in a Chapter 7 liquidation and not a reorganization; and 2) the bankruptcy court failed to adequately analyze the extent of the adverse economic consequences.

In affirming the lower court, Adler II held that: 1) “Queenie simply requires an immediate adverse economic impact on the debtor's estate, without regard to whether the debtor filed for bankruptcy under Chapter 11 or any other chapter”; and 2) “The Second Circuit neither defined 'immediate' nor provided any detailed consideration of the consequences on the debtor's estate. Rather, the relationship between the parties was sufficient to meet the standard [and as such] the stay should be extended to [the debtor's] wholly owned corporation.” Id. at 249. Thus, Adler II concluded that Queenie applies to any (regardless of the chapter filed) debtor's wholly owned corporation.

In contrast, Pavers & Road Builders Dist. Council Welfare Fund v. Core Contracting of N.Y., LLC, noted that “Whatever may be said for [Queenie], it has no application here … ” 536 B.R. 48, 51 (E.D.N.Y. 2015) (denying extension of the Automatic Stay to non-debtor entities based on theories of alter ego). It noted that the “automatic stay is automatic as applied to a debtor because that is what the statute says. As to non-debtors, it is relief that is available, but it is not automatic.” Id. at 53. This is consistent with prior jurisprudence. “Most, if not all courts consider the extension of the automatic stay under Code Section 362(a) to a nondebtor to be extraordinary relief … this Court has found that when an extension is allowed it is in circumstances where the debtor is a corporation and the nondebtor is an individual or related corporation deemed necessary for the reorganization … ” In re McCormick, 381 B.R. 594, 601 (Bankr. S.D.N.Y. 2008). See also, e.g., Reliant Energy Servs., 349 F.3d at 825–26; Favorito Elec., Inc., 2010 WL 985307 (E.D.N.Y. Mar. 15, 2010); In re Cheyenne Sales Co., No. 09–741, 2009 WL 1405015 (Bankr.N.D.W.Va. May 19, 2009).

Retroactive Application of The Automatic Stay: Piercing the Corporate Veil

Adler I retroactively extended the Automatic Stay to an alter ego and found the judgment was retroactively void ab initio. The retroactive extension of the Automatic Stay may well result in significant complexity. To apply the stay where it is alleged that a non-debtor is an alter ego requires a court finding that: 1) there is a piercing of the corporate veil; and 2) there is an immediate adverse effect on the estate. If it is determined post-petition that the automatic stay extends to a non-debtor entity as a pre-petition alter ego, then based on Adler I, they are void ab initio. This creates a twilight zone for plaintiffs prior to that determination because proceeding in a non-bankruptcy court risks any post-petition relief from the non-bankruptcy court being voided by an alter ego determination and also because a bankruptcy court would likely lack jurisdiction over non-debtor entities prior to piercing the veil

Pavers further differed from Adler I regarding the retroactive application of the automatic stay. Pavers argued that the retroactive application of the Automatic Stay, based on theories of alter ego, is unfair to parties whose prior efforts against a non-debtor entity would be invalidated by such an application. “[T]he Bankruptcy Court's dictum makes the automatic stay into a provision that can only be applied with the benefit of hindsight. It allows extensive litigation in the non-bankruptcy court, and then invalidates everything that occurred even though the debtor made no effort to stop it.” Pavers, 536 B.R., 51.

Lese Majeste: Limiting Queenie

It can be argued there are three primary factors mitigating against a broad interpretation of Queenie. These include:

1. The case law relied upon by Queenie. There is a tension between Queenie's broad language and the narrow precedent the Second Circuit relied upon. Queenie appears to apply to all property that is wholly owned by the Debtor, irrespective of whether it will impact a reorganization. Queenie did not discuss how immediate or the extent of the harm on his estate or, if it was necessary to the reorganization. In contrast, the precedent that the Circuit relied upon required “unusual circumstances” — generally associated with § 105 — to expand the automatic stay. See , e.g. , A.H. Robins Co. v. Piccinin , 788 F.2d 994, 999 (4th Cir.1986) (“likelihood of success by the debtor. Appeared indisputable” and “hardships which would be suffered irreparably by the debtor and by its creditors”) and Johns-Manville Corp. v. Asbestos Litigation Group (In re Johns-Manville Corp.), 26 B.R. 420, 435-36 (Bankr.S.D.N.Y.1983) (prohibiting suits against insurer to “insure uniform treatment of all asbestos-related health claimants”). In these toxic tort cases, even without the benefit of § 105 or § 362, a court may have well entered an injunction staying litigation in other forum to insure fair treatment of all the claimants. See , e.g. , A.H. Robins, 788 F.2d 994, 999. In contrast to the significant hurdles associated with these cases, Queenie appears to only require an immediate adverse economic impact on the Debtor.

2. The language of § 362. Queenie appears to ignore the plain language of the automatic stay of 11 U.S.C. § 362, which provides that “the automatic stay protects only the debtor, not non-debtor entities … . If the non-debtor entity wants that protection, it need only file its own petition.” Pavers, 536 B.R. 48, 51. Likewise, “immediate adverse economic consequences” is consistent with the equitable standard of § 105 and not automatic standard of § 362.

3. The portion of Queenie addressing the Automatic Stay is a side issue, at best, in a complex and exasperating case. Finally, the lower courts are likely influenced by the fact that Queenie's discussion of the Automatic Stay appears to be almost an afterthought and was not by any means the focus of the complex case. The Second Circuit was faced with “a choice between enforcing the forfeiture or burdening parties, witnesses, jurors, and the trial court with a retrial.” Queenie, 321 F.3d at, 283-84. Consistent with its prior actions, the Second Circuit found that the parties' briefing was of limited use, at best. Significantly, no party objected to the application of the automatic stay. Queenie, 321 F.3d at 287.

These three factors provide more than ample basis for lower courts to narrowly interpret Queenie under the rubric of § 105.

Conclusion

In Queenie, the Second Circuit appeared to broadly interpret the application of the automatic stay to include wholly owned non-debtor entities. As discussed, the majority of lower courts' narrower view can be reconciled with Queenie and, perhaps as a result, have generally not suffered reversal. In contrast, Adler I and Adler II's broad view is consistent with Queenie's language, and, as such, they cannot be consigned to a minority opinion. Adding to this confusion of 13 years, the Second Circuit has failed to rule definitively about the scope of the Queenie decision and when presented with the opportunity, it merely held that Queenie cannot being ignored and must be considered. Thus, creditors and debtors, especially in the EDNY, must be aware of the uncertainty regarding the scope of Queenie and consider it in their calculus.

Further, the possibility that an alter ego can be determined and the automatic stay can be voided retroactively can create a paralysis until the alter ego is determined. This is a very real concern based on the split in the District Court for the Eastern District of New York. However, as Pavers noted, “it is well established that non-bankruptcy courts have concurrent jurisdiction with the bankruptcy court to determine the scope of the automatic stay.” Pavers, 536 B.R., 51, citing In re Baldwin-United Corp. Litig., 765 F.2d 343 (2d Cir.1985). Thus, to avoid the risk of the retroactive application of the Automatic Stay to the non-Debtor entity, a plaintiff should ensure that the non-bankruptcy court make its implicit finding, that the automatic stay is not applicable to the non-debtor entity, explicit.

*****
Yitzhak Greenberg is of counsel with Bronstein, Gewirtz & Grossman, LLC, a litigation boutique in New York City. His practice is focused on all aspects of bankruptcy, including the representation of both debtors and creditors. He can be reached at [email protected].