Why should a non-debtor enjoy the benefits of the automatic stay and the centralization of litigation to a single forum—the bankruptcy court—when it is not otherwise subject to the rules of bankruptcy? Historically, bankruptcy courts have offered that protection when the matter sought to be stayed has an effect on the debtor's estate. For example, claims against a debtor's officers for personal liability derivative of the debtor's are often stayed so that the officers and the debtor are not distracted from the chapter 11 process. In recent years—especially in light of the volume of asbestos-related bankruptcies and mass-tort litigation—non-debtor parties marginally related to the debtor, often as contracting parties, have sought bankruptcy court protection from mass-tort litigation in which the debtor, but for the chapter 11 filing, would be a codefendant. The protection is sought either through an injunction under §105 of the Bankruptcy Code or, as in the case of In re Federal-Mogul Global Inc., 282 B.R. 301 (D. Del.) (Wolin, J.), mandamus denied, 300 F.3d 368 (3d Cir. 2002), cert. denied, 71 U.S.L.W. 3339 (2003), through removal of the case and transfer to the court where the bankruptcy is pending.

A threshold question that a court must address before determining whether it should, in its discretion, issue an injunction or permit the transfer of the case is whether the court even has jurisdiction over the matter. The jurisdiction of bankruptcy courts is grounded in and limited by statute. 28 U.S.C. §1334(b); 28 U.S.C. §157(a). Section 1334(b) provides that "the district courts shall have original but not exclusive jurisdiction of all civil proceedings arising under Title 11, or arising in or related to cases under Title 11." Since litigation among non-debtors does not arise under the Bankruptcy Code or in a bankruptcy case, the only potential basis for jurisdiction is that the litigation is "related to" the bankruptcy case.

Most circuit courts have adopted the test first articulated in Pacor Inc. v. Higgins, 743 F.2d 984, 994 (3d Cir. 1984), for determining whether related-to jurisdiction exists:

[a] matter is related to the bankruptcy case for §1334 purposes if the outcome of that proceeding could conceivably have any effect on the estate being administered in bankruptcy... Moreover, an action is related to bankruptcy if the outcome could alter the debtor's rights, liabilities, options or freedom of action (either positively or negatively) and in any way impacts upon the handling and administration of the bankruptcy estate.

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One of the great strengths and benefits of the bankruptcy process is the ability to gather all disputes related to the debtor in a single forum.

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Applying this standard, the Third Circuit held that related-to jurisdiction did not extend to personal-injury litigation between non-debtor parties, neither of them affiliated with the chapter 11 debtor, stating: "At best, [the personal injury lawsuit] is a mere precursor to the potential third party claim for indemnification by [the defendant] against [the debtor]." Id. at 995. The chapter 11 debtor could not be bound by the litigation, so its estate could not be affected in any way. Id. Pacor has been expressly approved by the U.S. Supreme Court. Celotex Corp. v. Edwards, 514 U.S. 300, 308 (1995).

In Federal-Mogul, non-debtor codefendants Chrysler, Ford Motor, General Motors and other automakers were defendants in thousands of lawsuits brought by parties exposed to asbestos from the brake pads manufactured by Federal-Mogul. The automakers sought to transfer these lawsuits to the Delaware bankruptcy court, arguing that their cases were "related to" the debtors' chapter 11 case, thus conferring bankruptcy jurisdiction. The primary argument for the transfer was that the automakers would have significant indemnification claims against the debtor, which surely would have an adverse effect on the bankruptcy estate. But, based on the precedent set by Pacor and others, the court held that personal-injury litigation against non-debtors is not "related to" a chapter 11 case within the meaning of §1334(b) by reason of the non-debtors' claim of indemnity against the debtor. The court noted that "related-to bankruptcy jurisdiction [does] not extend to a dispute between non-debtors unless that dispute, by itself, creates at least the logical possibility that the estate will be affected." Federal-Mogul, 282 B.R. at 309. The court denied the motions to transfer on the basis that it could not exercise related-to jurisdiction over litigation between non-debtors based merely on the prospect that the non-debtor codefendant would have an indemnity claim against the debtors. Having concluded that the bankruptcy court lacked subject-matter jurisdiction over the claims, this court remanded the cases to their original state courts.

In determining that it lacked jurisdiction over the non-debtor litigation, the court in Federal-Mogul was not concerned that common facts would be litigated against the non-debtors, even if the debtor was a putative indemnitor, because no factual determination could be binding on the debtor's estate. Id. at 306. The court reasoned that an indemnitor could be bound by an underlying judgment only if given an opportunity to be heard and defend. Since the automatic stay prevents a debtor from being required to defend, the debtor cannot be bound:

Implicit in Pacor's rationale is that a debtor may not be prejudiced by its failure to defend a lawsuit against a third-party common-law indemnitee without de facto depriving the debtor of the benefit of the automatic stay of litigation against it.

Id. at n.3. The court proceeded:

The court sees no justification to take the situation of these movants [the non-debtor codefendants in litigation of Friction Product Claims] outside of the rule of Pacor. A judgment against them will not bind the debtors. No asset of the estate is threatened, nor is any re-ordering of creditors in the offing. It is true that recovery by asbestos claimants against the movants may give rise to claims, indeed very substantial claims, against the debtors in the future. It is at that time, when the movants appear as creditors of the estate and the facts underlying the liability are adjudicated in the context of the bankruptcy that the Friction Product Claims will affect the estate.

Id. at 311. The appeals court, in denying the defendants' request for a writ of mandamus, agreed with this reasoning since "any indemnification claims that the [automakers] might have against the debtors have not yet accrued and would require another lawsuit before they could have an impact on Federal-Mogul's bankruptcy proceeding." 300 F.3d 368, 382.

That one of the automakers claimed a right of indemnification by contract, not just common law, failed to persuade the court. Noting that the indemnification language appeared as boilerplate language in a form of purchase order, the court stated: "The question whether this purported indemnity agreement would be determined to bind the [debtors] is open and one not easily resolved. The court is unwilling again to rest subject-matter jurisdiction on this tenuous support." 282 B.R. at 311 (quoting In re Asbestos Litig., 271 B.R. 118, 124 (S.D. W.Va. 2001)). The court concluded: "To the extent that the validity of an indemnity agreement is in doubt, the directness between the third-party action and a judicial ruling that will affect the estate is attenuated." Federal-Mogul, 282 B.R. at 311-12.

Even in situations where an unequivocal indemnification agreement does exist, it is questionable whether jurisdiction would lie under Federal-Mogul. Observing that "cases in which related-to jurisdiction is founded solely on an indemnification agreement between otherwise unrelated parties are not the rule but the exception," the court declined to state a blanket rule. Id. at 312. The court was apparently troubled by a portion of the Pacor decision that could be interpreted to permit an indemnification agreement to confer jurisdiction over the underlying liability. Id. This concern was subsequently laid to rest by the Third Circuit, which, in denying mandamus, made clear that under the Pacor test, an indemnity agreement does not confer related-to jurisdiction over the underlying liability unless the agreement, without any further legal proceeding, would automatically have an effect on the bankruptcy. 300 F.3d at 382. The test as articulated by the Third Circuit makes no distinction between contractual and common-law indemnification or between clear and disputable indemnity obligations. The sole issue is whether there will be a direct impact on the bankruptcy.

Federal-Mogul has not been universally accepted. Two recent decisions, both involving the same facts, demonstrate disparate views of related-to jurisdiction. In both New York City Employees' Retirement System v. Ebbers (In re Worldcom Inc. Securities Litigation), 293 B.R. 308 (S.D.N.Y. 2003), and Retirement Systems of Alabama v. J.P. Morgan Chase & Co., 285 B.R. 519 (M.D. Ala. 2002), holders of pension funds and others sued various parties, including underwriters, for securities fraud in connection with the WorldCom bankruptcy. In both cases, the non-debtor defendants removed the litigation on the basis that it was related to the WorldCom case because, among other reasons, the defendants had entered into underwriting agreements that included indemnification provisions. Following Federal-Mogul, the court in Alabama remanded the cases; holding that the court's reading of Pacor in Federal-Mogul was too narrow, the court in New York denied the remand motion.

One of the great strengths and benefits of the bankruptcy process is the ability to gather all disputes related to the debtor in a single forum. But there are and need to be reasonable jurisdictional limits. Federal-Mogul, even more equivocally than Pacor, places those limits beyond the reach of third parties whose only connection with a bankruptcy case is the debtor's indemnity obligation. Whether other courts follow the lead remains to be seen.