In a decision that reaffirms its previous rulings on the jurisdictional limits of bankruptcy courts, the US Court of Appeals for the Third Circuit recently held in W.R. Grace & Co. v. Chakarian (In re W.R. Grace & Co.)1 that bankruptcy courts lack subject matter jurisdiction over third-party actions against non-debtors if such actions could affect a debtor’s bankruptcy estate only following the filing of another lawsuit.

The limits of the subject matter jurisdiction of a bankruptcy court are set forth in Sections 1334(b) and 157(a) of Title 28 of the US Code. Section 1334(b) states that “district courts shall have original but not exclusive jurisdiction of all civil proceedings arising under [T]itle 11 [the Bankruptcy Code] or arising in or related to cases under [T]itle 11.” Section 157(a) provides, in turn, that a district court may refer “any or all proceedings arising under [T]itle 11 or arising in or related to a case under [T]itle 11…to the bankruptcy judges for the district.” Thus, a bankruptcy court may have subject matter jurisdiction over actions between non-debtors only if the court determines that the action “relate[s] to” a bankruptcy case.

Interpreting these statutes in the seminal case of Pacor, Inc. v. Higgins, the Third Circuit held that a civil proceeding between non-debtors is related to a bankruptcy case (and therefore may be enjoined) when “the outcome of that proceeding could conceivably have any effect on the estate being administered in bankruptcy.”2 Subsequently, in In re Federal-Mogul Global Inc., the Third Circuit refined the Pacor standard, holding that no “related-to” jurisdiction existed over a third-party action “if there would need to be another lawsuit before such [action] could have any impact on the bankruptcy proceedings.”3 And in 2004, the Third Circuit reviewed a prepackaged bankruptcy plan that included an injunction barring asbestos-related claims against two non-debtor entities under Section 105(a) of the Bankruptcy Code in In re Combustion Engineering, Inc.4 The court concluded that there was no basis for finding “related-to” jurisdiction to enjoin claims against the non-debtors because even if such parties could bring a potential claim for indemnification against the debtor, it nonetheless “would require the intervention of another lawsuit to affect the bankruptcy estate.”5

Building off the foregoing decisions, the Third Circuit in W.R. Grace held that a plan injunction barring asbestos-related claims against W.R. Grace and certain affiliated entities would not be extended to enjoin third-party actions against the state of Montana. That state was the defendant in certain lawsuits alleging that it was negligent in failing to warn residents of the risks associated with W.R. Grace’s asbestos mining operations. The state had petitioned the bankruptcy court for permission to implead the debtor as a third-party defendant. As a result, W.R. Grace separately argued that the injunction should be expanded to cover the Montana actions because Montana and W.R. Grace shared an “identity of interests” such that the Montana actions were essentially suits against the debtor.6 The Bankruptcy Court declined to extend the injunction, holding that it lacked the requisite “related-to” subject matter jurisdiction to grant the requested relief because the debtor’s bankruptcy estate would not be directly affected by the outcome of the Montana actions. Instead, the bankruptcy court concluded that Montana would first have to be found liable in state court, and then would have to initiate a separate lawsuit seeking indemnification before the debtor’s bankruptcy estate would feel any effect.

The Third Circuit affirmed, finding that, as in Pacor, Federal-Mogul, and Combustion Engineering, the debtor would not be bound by any judgment entered against Montana. The Third Circuit further found that the debtor’s “unity of interest” argument failed because Montana’s potential liability sprang from an independent legal duty to warn of the hazards of the debtor’s mining operations, and, in any event, this mere potential claim for indemnification would not be enough to establish “related-to” jurisdiction.

The Third Circuit further held that a bankruptcy court cannot, at the mere request of the debtor, disregard subject matter jurisdiction solely on the basis of the court’s jurisdiction over an adversary proceeding pending in the debtor’s bankruptcy. In this regard, the debtor and the state of Montana had argued that the bankruptcy court did not need “related-to” jurisdiction over the Montana actions in order to enjoin them because that court had jurisdiction over an adversary proceeding in which the injunctive relief was sought. The Third Circuit rejected this argument, stating:

If we were to accept Grace and Montana’s position…a bankruptcy court would have power to enjoin any action, no matter how unrelated to the underlying bankruptcy it may be, so long as the injunction motion was filed in an adversary proceeding. That notion stands in stark contrast to the basic premise that federal courts are courts of limited jurisdiction; they exercise only the authority conferred on them by Art[icle] III [of the US Constitution] and by congressional enactments pursuant thereto. The existence of a bankruptcy proceeding itself has never been and cannot be an all-purpose grant of jurisdiction.

In support of this holding, the Third Circuit looked to the US Supreme Court’s decision in Celotex Corp. v. Edwards,7 where the Supreme Court was asked to determine whether a bankruptcy court had jurisdiction to issue a Section 105(a) injunction that had the effect of enjoining an action pending in another judicial district. The Third Circuit found it critical that the Supreme Court did not automatically assume that the bankruptcy court’s jurisdiction over the adversary proceeding in and of itself conferred jurisdiction to enjoin the other action. Instead, the Supreme Court observed that bankruptcy court jurisdiction “is grounded in, and limited by, statute,” and thus must be based on the “arising under, arising in, or related to language of sections 1334(b) and 157(a).”8

Conclusion

By its decision in W. R. Grace, the Third Circuit affirmed yet again in clear terms that, in order for a bankruptcy court to have “related-to” jurisdiction to enjoin a lawsuit, the lawsuit must have the potential to affect the bankruptcy estate without another lawsuit first being filed. The jurisdictional limitations imposed upon bankruptcy courts identified in W. R. Grace are of particular importance to parties with potential actions or claims against a bankrupt entity’s non-debtor affiliates. In addition, lenders, equity investors, and other significant parties who regularly obtain third-party releases and/or injunctions pursuant to a plan of reorganization should take note of the Third Circuit’s limitations on the scope of potential plan injunctions.