Appellate Court Finds Plaintiffs' Claims Under Section 362 Not Automatically Stayed

Background

In October 2008, a group of hedge funds known collectively as the "Lancelot Funds" filed for bankruptcy protection under Chapter 7 of the Bankruptcy Code. During the Chapter 7 case, several investors filed lawsuits related to the Lancelot Funds, seeking recovery from nondebtor third parties based on claims arising out of alleged professional malpractice. The Chapter 7 trustee administering the Lancelot Funds' bankruptcy estate opposed the investor actions under Section 541 of the Bankruptcy Code, arguing that the investors' claims against a group of accounting firms and their principals (collectively referred to herein as McGladrey) who had audited the Lancelot Funds pre-bankruptcy were property of the bankruptcy estate. The trustee asserted, therefore, that the investors' lawsuits were barred by operation of the automatic stay of Section 362 of the Bankruptcy Code. Nonetheless, one group of investors known as "McKinley" proceeded with its state court action against McGladrey for professional malpractice and negligent misrepresentation.

In July 2009, the bankruptcy court ruled that McKinley's claims against McGladrey were property of the debtors' estate under Section 541 of the Bankruptcy Code and, consequently, were subject to the automatic stay. The bankruptcy court further opined that the trustee would be entitled to injunctive relief even if the investors' claims were not estate property because such claims were "substantially related to the estate." In so finding, the bankruptcy court cited its general equity powers under Section 105 of the Bankruptcy Code, which authorizes bankruptcy courts to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions" of the Code.  The bankruptcy court provided this alternative basis for its holding based on substantial similarities between the trustee's action against McKinley and the case of Fisher v. Apostolou, 155 F.3d 876 (7th Cir. 1998). In Fisher, a Chapter 7 trustee successfully sought to enjoin allegedly defrauded investors from pursuing a non-debtor party against whom the trustee had commenced an adversary proceeding in the bankruptcy case. Reviewing the bankruptcy court's injunction, the Fisher court rejected the application of the automatic stay to the investors' claims, but affirmed the bankruptcy court's use of its general equity powers under Section 105 to enjoin the claims. In citing to Fisher, the bankruptcy court applied Section 105 and issued an order enjoining McKinley's claims, finding that such injunctive relief was warranted in order to "promote the general policies of bankruptcy and an orderly administration of the estate." The injunctive order was subsequently dissolved in September 2015.