“[T]he 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.”
– Judge Brian M. Cogan (E.D.N.Y.), August 20, 2015

Just what actions are stayed by virtue of a debtor’s bankruptcy filing? And who is protected by that automatic stay?  The long answer to those questions is complex, but a decision issued this summer illustrates some of the considerations to be taken into account in assessing the length and breadth of the automatic stay and the proper forum for determining whether and how to extend those protections to nondebtors. 

In a litigation captioned Pavers & Road Builders Dist. Council Welfare Fund v. Core Contracting of NY, LLC, administrators of an ERISA pension fund and the union that set up that fund brought an action in the United States District Court for the Eastern District of New York, seeking unpaid pension contributions from four signatories to a collective bargaining agreement, each of which was alleged to be the alter ego of the other entities.

One of the named defendants (Canal Asphalt) subsequently commenced a chapter 11 case in the United States Bankruptcy Court for the Southern District of New York, which automatically stayed the litigation against it in the district court.  Shortly thereafter, all four of the defendants wrote a letter to the district court, advising it of Canal Asphalt’s chapter 11 filing and asserting that as a result, the district court litigation was stayed against all four defendants.  In response, the district court noted that the automatic stay applied only to Canal Asphalt, and that the district court litigation would proceed as against the remaining three (nondebtor) defendants.  The defendants then submitted a second letter, this time including a substantive argument that the stay applied to all of them, citing to alleged precedent in the United States Bankruptcy Court for the Eastern District of New York.

In their letter, the defendants relied on In re Adler (“Adler II”), in which the bankruptcy court considered an objection to the dischargeability of Adler’s debt.  That objection was, in turn, based on a prior decision in the state court, in which Adler’s creditors obtained a default judgment against five nondebtor corporations controlled by Adler.  (The bankruptcy court, in “Adler I,” had previously concluded that the state court lawsuit could proceed as against the nondebtor corporations, notwithstanding Adler’s bankruptcy.) In considering the objection to the dischargeability of Adler’s debt, the bankruptcy court, in Adler II, stated that:

As the Debtor and the alter ego Corporations were at all relevant times one and the same entity, the automatic stay in § 362(a)(1) foreclosed any judicial action against the Debtor and the Corporations alike upon the Debtor’s filing of his individual bankruptcy petition . . . . Consequently, to the extent any prepetition judicial action against the Corporations continued into the post-petition period, that proceeding violated § 362(a)(1) and was void as a matter of law. . . .

In other words, the automatic stay applied not just to the debtor, but to any nondebtors who are adjudged to be “one and the same entity” as the debtor.

Nevertheless, the bankruptcy court concluded that Adler and his corporations were liable as alter egos in the same amount as had been found by the state court.  Consequently, as Judge Cogan recognized inPavers & Road Builders, the language cited above, and relied upon by the defendants, was dictum.

In any event, Judge Cogan disagreed with the bankruptcy court’s statement in Adler II, noting that the Bankruptcy Code plainly provides that the automatic stay applies only to debtors, and not to nondebtors – even if they are alter egos of the debtor.  Judge Cogan further observed that applying the automatic stay to alter egos, as was suggested in Adler II, would mean that the automatic stay could only be given effect with the benefit of hindsight.  Specifically, that construction would allow extensive litigation to take place in a nonbankruptcy court, after which such litigation would be invalidated if the nondebtor is subsequently adjudged to be the debtor’s alter ego.

Judge Cogan then further noted that the automatic stay may still be extended to nondebtors, if “unusual circumstances” exist warranting an extension of the stay, for example, through an adversary proceeding for an anti-suit injunction, or pursuant to a chapter 11 plan.  Such a stay of action against nondebtors may be appropriate where it is designed to protect the debtor (or to confirm and implement a chapter 11 plan), but it is not automatic, regardless of the nondebtor’s relationship with the debtor.  The district court then acknowledged that the decision to stay such actions against nondebtors is not for the nonbankruptcy courts to decide, as they are not charged with protecting the debtor or its creditors – nor did the district court have the practical ability to do so, given the record before it.  In Judge Cogan’s words, “[t]hat is just not my problem.”

Indeed, Judge Cogan came close to questioning the decision in Queenie, Ltd. v. Nygard Int’l, in which the Second Circuit Court of Appeals held that the automatic stay applied to a nondebtor “because it is wholly owned by [the debtor], and adjudication of a claim against the corporation will have an immediate adverse economic impact on [the debtor.]”  The district court wryly noted, “[w]hatever may be said for [Queenie], it has no application here, for I have no way to conclude, even if it was within my purview to do so, that pursuit of the claims against the non-debtors would have either an immediate or an adverse effect on the debtor.”

In closing, Judge Cogan reiterated his central point – the automatic stay does not, and should not, automatically apply to nondebtors, regardless of whether they are alleged to be alter egos of the debtor.  He recognized that the nondebtor defendants could conceivably pursue a number of avenues for relief – via an injunction in the bankruptcy court extending the stay to nondebtors and/or a motion to transfer the case to the Southern District of New York, after which it could potentially be referred to the bankruptcy court where Canal Asphalt’s chapter 11 case was pending.

Fascinating issues indeed.