The U.S. Court of Appeals for the First Circuit recently overturned its own prior guidance to hold that an official creditors’ committee had an unconditional statutory right to intervene in an adversary proceeding. The First Circuit joined the Second and Third Circuits to recognize that the right to intervene provided by the Bankruptcy Code is not limited to the main bankruptcy case, contrary to the long-standing rule in the Fifth Circuit. However, the First Circuit also held that the scope of intervention may be qualified, with limits set by the trial court on a case-by-case basis.

Background

The interpretation of Section 1109(b) of the Bankruptcy Code arose as an issue when the Official Committee of Unsecured Creditors (UCC) in Puerto Rico’s bankruptcy proceedings under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), 48 U.S.C. §§ 2161-2177, sought to intervene in an adversary proceeding commenced by Assured Guaranty Corp. and other insurers of Puerto Rican bonds. The plaintiffs sought to prevent implementation of Puerto Rico’s proposed fiscal plan on the grounds that the plan and a statute intended to implement the plan violated PROMESA and the U.S. Constitution.

The UCC filed a motion to intervene under Federal Rule of Civil Procedure Rule 24, which applies to adversary proceedings in a bankruptcy case. Rule 24 states that “the court must permit anyone to intervene who ... is given an unconditional right to intervene by a federal statute.” Fed. R. Civ. P. 24(a)(1). The UCC’s main argument was that Section 1109(b) of the Bankruptcy Code, which applies in a Title III case under PROMESA, confers such an unconditional right. The statute provides that any “party in interest,” expressly including a creditors’ committee, “may raise and may appear on any issue in a case under this chapter.” 11 U.S.C. § 1109(b). The plaintiffs opposed the UCC’s motion to intervene. Puerto Rico’s oversight board filed a limited opposition, urging limits on the scope of the UCC’s intervention, which the UCC, in its reply, said it would accept.

The District Court overseeing the Title III case, however, denied the UCC’s intervention altogether. With respect to intervention based on a statutory right, the District Court relied on a footnote in Kowal v. Malkemus (In re Thompson), 965 F.2d 1136, 1142 n.8 (1st Cir. 1992), where the First Circuit stated in dicta that Section 1109(b) “does not afford a right to intervene under Rule 24(a)(1).” The District Court also rejected the UCC’s request for permissive intervention (which does not rely on Section 1109(b) of the Bankruptcy Code).

The First Circuit Ruling

The First Circuit overruled the District Court in Assured Guaranty Corp. v. Fin. Oversight and Mgmt. Bd. for Puerto Rico, No. 17-1831, 2017 U.S. App. LEXIS 18387 (1st Cir., Sept. 22, 2017). The appellate court stated that it was “certainly understandable for the district court to rely on” the footnote in Thompson, “which appears directly applicable to the present case. Id. at *7. But the First Circuit said that this footnote arose in a Chapter 7 case, in which Section 1109(b) does not apply, and was mere dicta that lacked binding effect.

In revisiting whether Section 1109(b) provides an unconditional right to intervene in an adversary proceeding, the First Circuit acknowledged that the Fifth Circuit has held that Section 1109(b) does not apply to adversary proceedings. Id. at *9 (citing Fuel Oil Supply & Terminaling v. Gulf Oil Corp., 762 F.2d 1283 (5th Cir. 1985)). In Fuel Oil, the Fifth Circuit conceded that, based on a plain reading of the Bankruptcy Code, the argument that Section 1109(b) created an absolute right to intervene in adversary proceedings “appears strong.” 762 F.2d at 1286. But the court diverged from that plain meaning based on a policy against finding unconditional rights of intervention and other statutory language and rules that distinguished between bankruptcy “cases” and related “proceedings.” Id. The Fourth and Tenth Circuits have suggested agreement with this analysis. See Richman v. First Woman’s Bank (In re Richman), 2014 F.3d 654, 658 (4th Cir. 1997); Vermejo Park Corp. v. Kaiser Coal Corp. (In re Kaiser Steel Corp.), 998 F.2d 783, 790 (10th Cir. 1993).

The First Circuit found, however, that “the weight of persuasive authority has shifted considerably” in the 30 years since Fuel Oil, citing cases in which the Second and Third Circuits declined to follow Fuel Oil and instead held that Section 1109(b) does apply to adversary proceedings. Assured Guaranty Corp., 2017 U.S. App. LEXIS 18387, at *9-10 (citing Term Loan Holder Comm. v. Ozer Grp., L.L.C. (In re Caldor Corp.), 303 F.3d 161 (2d Cir. 2002); Phar-Mor, Inc. v. Coopers & Lybrand, 22 F.3d 1228 (3d Cir. 1994)). The First Circuit held that these circuits have the “better view.” Id. at *10.

In explaining its conclusion, the First Circuit extensively quoted the Second Circuit’s decision in Caldor, the most recent appellate opinion to decide the issue. Id. The First Circuit also observed that the Section 1109(b) reference to “any issue in a case” is “quite broad,” and subsumes issues in a proceeding, since every issue in a case is raised and adjudicated in a proceeding of some kind. Id. at *11.

The First Circuit cautioned, however, that its holding that Section 1109(b) of the Bankruptcy Code provided the UCC with an unconditional right to participate in the adversary proceeding did not dictate the “scope of that participation,” which instead remains within the broad discretion of the trial court. Id. at *12. Possible limitations cited by the First Circuit include a determination that an intervening party cannot preclude others from settling their own disputes, limiting intervention to the claims raised by the original parties, and denying discovery for intervenors, at least in some circumstances. Id. at *13. In a footnote, the First Circuit also noted that the standing requirement under Article III of the U.S. Constitution provides a possible limitation on participation in adversary proceedings. Id. at *14 n.7. Ultimately, the First Circuit remanded the UCC’s motion to the District Court to determine the scope of intervention in this case. Id. at *13-14.

Conclusion

A growing consensus has emerged in favor of intervention in adversary proceedings as a matter of statutory right. The fact the First Circuit adopted this approach despite its previous guidance to the contrary raises the question of whether other circuits following the opposite rule could be persuaded to reverse course. The issue does not merely have consequences for official committees like the UCC; the First Circuit’s statutory analysis applies equally to equity committees, creditors, equity holders and indenture trustees, which are all also identified in Section 1109(b). However, even under the majority rule, the scope of intervention will vary from case to case and, potentially, party to party.