In the W.R. Grace bankruptcy, the United States Court of Appeals for the Third Circuit recently reaffirmed its prior rulings on the controversial issue of a bankruptcy court’s power to enjoin actions by third parties against non-debtors.1 Resting on prior precedent, the Third Circuit held that bankruptcy courts lack subject matter jurisdiction to enjoin third party actions that have no direct effect upon the bankruptcy estate. This decision is particularly noteworthy for parties with potential claims against non-debtor affiliates of debtors, as those parties will be better able to pursue their claims against those non-debtor affiliates, unless the bankruptcy court finds the actions will have a direct effect on the bankruptcy estate.
Before a bankruptcy court can issue an injunction, it must establish subject matter jurisdiction over the parties against whom the injunction is sought.2 The bounds of federal bankruptcy court jurisdiction are defined by 28 U.S.C. §§ 1334(b) and 157(a).3 Section 1334(b) states that federal district courts “have original but not exclusive jurisdiction of all civil proceedings arising under title 11 [the Bankruptcy Code], or arising in or related to cases under title 11.”4 Section 157(a) permits a district court to refer “any or all proceedings arising under title 11 or arising in or related to a case under title 11” to the bankruptcy judges within the district.5 In the context of enjoining third party actions, the Third Circuit has a well developed body of case law clarifying which proceedings are “related to a case under title 11,” and therefore within the jurisdiction of bankruptcy courts. In the frequently cited Pacor, Inc. v. Higgins decision, the Third Circuit developed the “any conceivable effect” test to determine “related to” jurisdiction, which inquires as to “whether the outcome of [the relevant] proceeding could conceivably have any effect on the estate [in bankruptcy].”6 The Pacor court elaborated that “[a]n action is related to bankruptcy if the outcome could alter the debtor’s rights, liabilities, options, or freedom of action. . . and . . . in any way impacts upon the handling and administration of the bankrupt estate.”7 The court made clear that a party’s inchoate claim of common law indemnity against a debtor is not, in and of itself, enough to establish the bankruptcy court’s subject matter jurisdiction over an action brought against that party.8
Eighteen years after Pacor, the Third Circuit reaffirmed and clarified the Pacor test in In re Federal-Mogul Global, Inc.9 The Federal-Mogul court stated that “the test articulated in Pacor. . . inquires whether the allegedly related lawsuit would affect the bankruptcy proceeding without the intervention of yet another lawsuit.”10 The Federal-Mogul court ultimately held that there was no “related to” subject matter jurisdiction to enjoin an action by a third party against a non-debtor because the indemnification claim held by the non-debtor against the debtors had “not yet accrued and would require another lawsuit before [having] an impact on [the debtor’s] bankruptcy proceeding.”11
More recently, in Combustion Engineering, the Third Circuit examined additional grounds for “related to” jurisdiction. In Combustion Engineering, the debtor argued that a unity of interests between the debtor and its non-debtor affiliates based on the debtor’s potential indemnity obligations to the affiliates, as well as the existence of both a shared production site and shared insurance, provided sufficient basis for “related to” jurisdiction to permit the court to enjoin an action by a third party against the non-debtor affiliates.12 The court found, however, that, based on prior rulings of the Third Circuit and in the absence of any derivative liability “[a]ny indemnification claims against Combustion Engineering . . . would require the intervention of another lawsuit to affect the bankruptcy estate, and thus cannot provide a basis for ‘related to’ jurisdiction.”13
W.R. Grace Decision
From 1963 to 1990 W.R. Grace operated a vermiculite mine in Montana and produced specialty chemicals and materials. The by-products of the mine operations allegedly exposed a number of residents and mine workers to asbestos. Thereafter, asbestos claimants filed suit against Grace in Maryland state court. On April 2, 2001 W.R. Grace filed for bankruptcy to seek protection from liabilities associated with this asbestos litigation and on the same day W.R. Grace commenced an adversary proceeding to halt prosecution of the litigation. The Bankruptcy Court entered a preliminary injunction pursuant to 11 U.S.C. § 105(a), enjoining the litigation against Grace and certain of its non-debtor affiliates.
Prior to Grace’s bankruptcy filing, the claimants in the asbestos litigation also filed lawsuits in Montana courts against the State of Montana alleging that Montana was negligent in failing to warn the claimants of the risks of asbestos in the Grace mine. When it was determined by the Montana Supreme Court that the State of Montana had a duty to “gather public health-related information and provide it to [its citizens]” the State of Montana sought relief from the automatic stay to implead Grace as a third party defendant. Grace opposed the State of Montana’s motion and filed its own motion asking the Bankruptcy Court to expand the preliminary injunction to include actions brought against the State of Montana, arguing that Grace and the State of Montana share an identity of interests such that the suits against the State of Montana were essentially suits against Grace, and thus harmful to Grace’s reorganization efforts.
The Bankruptcy Court denied Grace’s motion to extend the injunction to the actions against the State of Montana, finding that it did not have subject matter jurisdiction over those actions.14 The Bankruptcy Court noted that the result of the actions against the State of Montana would have no direct effect on Grace’s bankruptcy estate.15 The fact that the State of Montana would have to pursue an additional claim against Grace for indemnification prevented the Bankruptcy Court from having the necessary “related to” jurisdiction to stay the action against the state. On appeal, the District Court affirmed the Bankruptcy Court’s decision, stating that Grace “will not be bound by a judgment against the State of Montana in the state court actions [because] a separate adjudication is necessary to affect Debtor’s estate.”16
Third Circuit’s Analysis
Reaffirming the precedent established by Pacor and its progeny, the Third Circuit upheld the decisions of the lower courts and found that the Bankruptcy Court did not have the authority to enjoin the state court actions asserted against the State of Montana. In reaching its decision, the Third Circuit noted that asserting “related to” subject matter jurisdiction over third party actions is inappropriate where the result of the third party action, absent an additional lawsuit, would not have a direct effect on the bankruptcy estate in question.
The Third Circuit likened Grace to Pacor, Federal Mogul, and Combustion Engineering, stating “our recently reaffirmed precedent dictates that a bankruptcy court lacks subject matter jurisdiction over a third-party action if the only way in which that third-party action could have an impact on the debtor’s estate is through the intervention of yet another lawsuit.”17 Further, just as in Combustion Engineering, the Third Circuit rejected the “unity of interests” argument because the State of Montana is not a private entity or even in the business of producing asbestos, and the State of Montana’s potential liability was based on an independent legal duty owed to the people of the state.18
The W.R. Grace decision is further affirmation of the Third Circuit’s “any conceivable effect” test as established by Pacor and clarified by Federal-Mogul and Combustion Engineering. In the absence of any direct effect on the debtor’s estate, a bankruptcy court in the Third Circuit is without authority to enjoin actions against non-debtors, despite the prospect of an indemnity lawsuit later being asserted against the debtor.