The Bottom Line:

While the automatic stay bars actions directly against a debtor and its property, there are instances when actions against non-debtor third parties nonetheless indirectly affect the bankruptcy estate. In these cases, the debtor may ask the court to extend the automatic stay to enjoin actions against the non-debtor. In In re Residential Capital, LLC, 12-3342, 2013 WL 3491311 (2d Cir. July 15, 2013), the United States Court of Appeals for the Second Circuit recently clarified that even if the stay does not automatically protect non-debtors, the stay may apply to certain non-debtors where the action against the non-debtor “will have an immediate adverse economic consequence for the debtor’s estate.” In doing so, the Second Circuit rejected the District Court per se holding that the automatic stay never applies to non-debtors and remanded the matter back to the District Court to supplement the record and, given the Second Circuit’s clarification of the law, determine whether the automatic stay applies to the non-debtor parent and affiliate entities under the facts of the case. 

What Happened:

Residential Capital, LLC and a number of its affiliates (“ResCap”) filed for bankruptcy protection on May 14, 2012. (Kramer Levin represents the Creditors’ Committee in these Chapter 11 cases). The Federal Home Loan Mortgage Corporation (“Freddie Mac”) had purchased mortgage-backed securities from ResCap prior to the collapse of the real estate market. The Federal Housing Finance Agency (“FHFA”), as conservator of Freddie Mac, sued ResCap and its parents and affiliates in 2007 for violations of various federal and state laws in connection with their sale of the mortgage-backed securities Freddie Mac purchased from ResCap. 

After ResCap commenced the Chapter 11 cases, actions against the debtors were stayed by operation of section 362 of the Bankruptcy Code (the “automatic stay”). FHFA amended its prepetition complaint to remove ResCap from its lawsuit so it could pursue ResCap’s non-debtor parents and affiliates. ResCap then filed an adversary proceeding in the Bankruptcy Court asking the court to rule that ResCap’s non-debtor parents and affiliates were already protected by the automatic stay or, in the alternative, to extend the automatic stay to ResCap’s non-debtor parents and affiliates (the “Stay Motion”). 

The District Court granted a motion by FHFA to withdraw the adversary proceeding to the District Court and ultimately denied all relief sought in ResCap’s Stay Motion, holding categorically that the automatic stay does not apply to non-debtors and that it would not exercise its discretion to extend the automatic stay to ResCap’s parents and affiliates. ResCap appealed the District Court’s denial of the Stay Motion to the Second Circuit. 

In its briefing, among other arguments, ResCap argued that the Second Circuit’s decision in Queenie, Ltd. v. Nygard Int'l, 321 F.3d 282, 287 (2d Cir. 2003) (holding that the automatic stay applied to a debtor’s wholly owned non-debtor subsidiary) demonstrates that the automatic stay can apply to non-debtors. In response, FHFA argued that Queenie was distinguishable because there, the non-debtor was a wholly owned subsidiary of the debtor, while here, the non-debtors in question are parents or affiliates of the ResCap debtors. 

The Second Circuit sided with ResCap and disagreed with the District Court’s categorical assertion that the automatic stay never protects non-debtors. Not convinced by FHFA’s efforts to distinguish Queenie, the court explained that Queenie stood for the proposition that while the automatic stay does not normally apply to non-debtors, it nevertheless applies “when a claim against the non-debtor will have an immediate adverse economic consequence for the debtor’s estate.” Id., at 287. The court in Queenie explained that the automatic stay may apply to a non-debtor where, for example, it is a guarantor or insurer of the debtor or where “there is such an identity between the debtor and the third-party defendant that the debtor may be said to be the real party defendant . . . .” Id., at 288 (quoting A.H. Robins Co. v. Piccinin, 788 F.2d 994, 999 (4th Cir.1986). 

As such, the Second Circuit held that the automatic stay may apply to ResCap’s non-debtor parents and affiliates if FHFA’s actions against them would have an immediate economic impact on ResCap. Because the District Court failed to make factual findings as to whether the lawsuit against ResCap’s parents and affiliates had an immediate adverse economic impact, the matter was remanded to the District Court to supplement the record regarding the consequences to the debtors’ estates if FHFA’s action against ResCap’s non-debtor parents and affiliates were to continue and, as such, make a determination as to whether the automatic stay applies under those circumstances. 

Why the Case is Interesting:

This case is notable for two reasons. First, it demonstrates that the Second Circuit’s earlier holding in Queenie that the automatic stay may protect non-debtors is not limited to the narrow circumstance where the non-debtor is a wholly owned subsidiary of the debtor. It is also notable in that debtors need not rely exclusively on the court’s discretion under section 105 of the Bankruptcy Code to “extend” the automatic stay to non-debtors – the statutory automatic stay applies may apply to certain non-debtors by its own terms where the action against the non-debtor “will have an immediate adverse economic consequence for the debtor’s estate.”