Bankruptcy as a Litigation Tactic: Sometimes You Win, Sometimes You Lose

Bankruptcy as a Litigation Tactic: Sometimes You Win, Sometimes You Lose

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Using bankruptcy as a tactic to gain leverage in complex commercial litigation is nothing new; however, the scope and timing of playing the bankruptcy card have differing impacts and results. At the narrowest end of the spectrum is the chapter 11 filing by an otherwise financially sound company in an attempt to utilize the proceeding solely as a means to deal with potentially crippling litigation. At the broadest end of the spectrum is the chapter 11 filing by an insolvent company that utilizes its bankruptcy proceeding as a litigation tool to deal with pending litigation. While the former might ensure a dismissal of the case, having no impact on the pending litigation, the latter might ensure that the plaintiff in the litigation has submitted to jurisdiction in the bankruptcy court and lost its right to a jury trial—a catastrophic impact on the pending litigation.


Good-faith Dismissal

In a recent Third Circuit ruling, the court reversed the district court's decision and remanded the case for dismissal of a petition filed by a debtor who, by its own admission, was financially sound but facing antitrust litigation of considerable magnitude. In In re SGL Carbon Corp., the Third Circuit adopted a good faith filing requirement for chapter 11 proceedings and reversed the district court's rulings that the petition furthered the purpose of chapter 11 because the litigation imperiled the debtor's operations by distracting management and could potentially be financially ruinous. In re SGL Carbon Corp., 1999 U.S. App. Lexis 34433 *9 (3d Cir. 1999). The debtor in SGL Carbon had been quite vocal after filing its petition through press releases and deposition testimony about the financial soundness of the company and the use of the bankruptcy proceeding to more expeditiously resolve the litigation. Id. While these measures might be good for the ongoing business of the company, they were fatal to the bankruptcy process. After a fact-intensive inquiry, the Third Circuit found that the district court's findings of fact were clearly erroneous. Specifically, the court found that (i) the litigation did not have a material negative impact on the debtor's operations or otherwise serve as a distraction to management, and (ii) the petition was essentially premature given the fact that the debtor was financially solvent. Id. at *22-28. Based on equitable principles, the Third Circuit concluded that the debtor's chapter 11 petition lacked a valid reorganizational purpose and therefore lacked good faith. Id. at 46. In summation, the court stated the following:

We recognize that companies that face massive potential liability and litigation costs continue to seek ways to rapidly conclude litigation to enable a continuation of their business and to maintain access to the capital markets. As evidenced by SGL Carbon's actions in this case, the Bankruptcy Code presents an inviting safe harbor for such companies. But this lure creates the possibility of abuse which must be guarded against to protect the integrity of the bankruptcy system and the rights of all involved in such proceedings. Allowing SGL Carbon's bankruptcy under these circumstances seems to us a significant departure from the use of chapter 11 to validly reorganize financially troubled businesses.

Id. at *46-47.

Distinguishing the Texaco, Johns-Manville, A.H. Robins and Dow Corning cases and a litany of others (Id. at *25-28), the Third Circuit clearly noted the fine line it established in SGL Carbon. With the fact-intensive analysis and equitable nature of the remedy, more uncertainty of outcome is the only certain result.

Loss of Alternative Forum

In a situation in which the debtor does have a legitimate reorganizational purpose, the playing field flips to the debtor's advantage, often leaving the creditor-plaintiff without any alternative other than to file a proof of claim and otherwise participate in the bankruptcy proceeding, resulting in submission to the jurisdiction of the bankruptcy court for purposes of allowance or disallowance of the claim and the loss of a jury trial. See Langenkamp v. Culp, 111 S. Ct. 245 (1990); Granfinancieria S.A. v. Nordberg, 109 S.Ct. 2782 (1989); Katchen v. Landry, 86 S.Ct. 467 (1966); Germain v. Connecticut Nat'l Bank, 988 F.2d 1323 (2d Cir. 1993); Travellers Int'l AG v. Robinson, 982 F.2d 96 (3d Cir. 1992). While the creditor-plaintiff can take precautionary measures to avoid the bankruptcy court's jurisdiction (e.g., seeking relief from the automatic stay (11 U.S.C. §362(d)), filing the proof of claim under protest, seeking abstention as to a claim objection to allow the proceeding to go forward in the original court (28 U.S.C. §1334(c)) or removing the litigation to the bankruptcy court to allow for a jury trial in the bankruptcy court or in the district court (28 U.S.C. §1452(a)), losing the battle on any of these measures will result in the creditor-plaintiff having actively participated in the bankruptcy proceeding such that it has subjected itself to the bankruptcy court's jurisdiction without any meaningful right of appeal.1

These well-established rules make complete sense at first blush. Allowance or disallowance of a claim is certainly an issue that should remain within the sole province of the bankruptcy court.2 In addition, the bankruptcy court can frequently conclude the claim objection more expeditiously than the lawsuit in the alternative forum would otherwise proceed, thus assuring a more swift resolution of the bankruptcy process.

Nonetheless, there are scenarios under which the hard and fast nature of these rules might require re-examination, e.g., complex litigation involving more than one co-defendant. Once trapped in the bankruptcy court's province, the creditor-plaintiff is in the unenviable position of having to litigate its claims in two forums and face the potential prejudicial effect in one forum of a negative ruling in the other. The inherent inequities of this are even more obvious if the bankruptcy court's ruling precedes the jury trial in that the creditor-plaintiff could effectively be stripped of a meaningful right to a jury trial against the non-debtor co-defendants based on the bankruptcy court's findings.

Furthermore, a debtor can intentionally force a reluctant creditor-plaintiff into participating in its bankruptcy proceeding via tactics such as (i) scheduling the claim amount at zero, requiring the creditor-plaintiff to file a proof of claim to protect its rights, or (ii) neglecting to provide for the claim in its plan of reorganization, requiring the creditor-plaintiff to object to the plan to protect its rights. Once the creditor-plaintiff has actively participated in the bankruptcy proceeding, it has squarely subjected itself to the bankruptcy jurisdiction. See In re AVN, 235 B.R. 417 (Bankr. W.D. Tenn. 1999).

Even when the debtor has a legitimate reorganizational purpose for filing its bankruptcy, the debtor can take advantage of the bankruptcy proceeding—perhaps to the point of abuse—to oust a creditor-plaintiff from the original forum and strip it of its constitutional right to a jury trail.

Given the multitude of factual possibilities, simple bright-line rules on these issues are not practical or probable and the implementation of the rules on a bright-line basis lends itself to inequities. In sum, abuse of the process can go unremedied when the specific facts of each case are not carefully considered.


1 A split in authority exists with respect to whether all orders denying motions to lift the automatic stay are final. Some circuits hold that all orders denying relief from the stay are final. See In re Conejo Enters. Inc., 96 F.3d 346, 351 (9th Cir.1996); In re Sonnax Indus. Inc., 907 F.2d 1280, 1284-85 (2d Cir. 1990); Grundy Nat'l Bank v. Tandem Mining Corp., 754 F.2d 1436, 1439 (4th Cir. 1985); In re Leimer, 724 F.2d 744, 745-46 (8th Cir. 1984). Other circuits have held that whether an order denying relief is interlocutory or final depends on the particular reasons underlying the court's order. See In re Comer, 716 F.2d 168, 174 & n.11 (3d Cir. 1983). The Fifth Circuit has not specifically addressed the issue but has stated, in dicta, that "[o]rders granting or denying relief from the automatic stay [pursuant to §362] are final and appealable." In the Matter of Lieb, 915 F.2d 180, 185 n.3 (5th Cir. 1990). Whether the appeal is taken from an order granting relief from the automatic stay or denying such relief, the standard of review is "abuse of discretion." See In the Matter of Lentino, M.D., 1999 WL 77140 at *2 (5th Cir. 1999). As to abstention, a bankruptcy court's denial of a motion for abstention is interlocutory and may be appealed only with leave of the district court or the bankruptcy appellate panel. See In re Rupp & Bowman Co., 109 F.3d 237, 239-40 (5th Cir. 1997). When examining an order denying abstention, the reviewing court will apply the "abuse of discretion" standard. See In the Matter of Southmark Corp., 163 F.3d 925, 932 (5th Cir. 1999). Finally, although an order remanding a removed civil action is generally appealable, a controversy exists concerning whether such an order is final or interlocutory. Compare In re Midgard Corp., 204 B.R. 764 (B.A.P. 10th Cir. 1997), with In re Rupp & Bowman Co., 109 F.3d 237 (5th Cir. 1997). Return to article

2 It should be noted that by allowing the lawsuit to proceed in the alternative forum to liquidate a claim does not preclude the bankruptcy court from considering the claim amount through the allowance or disallowance of the liquidated claim in a different amount. See In re Bicoastal Corp. 158 B.R. 237 (Bankr. M.D. Fla. 1993.) Return to article

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Wednesday, March 1, 2000