3d Circuit Further Explains the Limited Scope of a Bankruptcy Court's Subject Matter Jurisdiction

[1/13/10 Update:  Thanks to Steve Sather from A Texas Bankruptcy Lawyer's Blog for his comment below.  In his post today, he discusses in greater length the opinion of Judge Edith Jones in holding that "related to" jurisdiction exists over a non-debtor dispute if the indemnity right is contractually based, and hence had already "accrued."  Lone Star Fund V (US), LP v. Barclays Bank, PLC, No. 08-11038 (5th Cir. 1/11/10) (pdf).

To further complicate matters, take a look at a recent decision of Judge Laurel Isicoff, who held that regardless of whether the Pacor test was satisfied, the court had "related to" jurisdiction over a third party franchisor's claims against the debtor's principal where the proceeding arose out of same core of facts as one whose outcome could have a Pacor-type effect, and thus the prerequisites for exercise of "supplemental jurisdiction" were satisfied. Century 21 Real Estate, LLC v. Prestige Realty Group of Ohio & Florida, LLC (In re Prestige Realty Group of Ohio & Florida, LLC), 2009 WL 3817297 (Bankr. S.D. Fla. 11/13/2009).  Respectfully, Judge Isicoff's ruling is not the law in the 7th Circuit, however, so be sure to check your local practice first.  See, Banc of America Inv. Servs., Inc. v. Fraiberg (In re Conseco, Inc.), 305 B.R. 281 (Bankr. N.D. Ill. 2004) (bankruptcy court cannot exercise supplemental jurisdiction under § 1367(a) because it is not a district court.and such exercise would amount to "related to related to" jurisdiction).  It's also a position at odds with 3rd Circuit's decision in In re Exide Techs., 544 F.3d 196 (3d Cir. 2008), which expressly rejected the “intertwinement” theory under which otherwise non-core disputes among non-debtors could be treated as core bankruptcy matters based on the extent of their "intertwinement" with core disputes between those parties and the debtor.]

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As noted in this post last June, it is fair to assume that the U.S. Supreme Court would not permit a bankruptcy court to adjudicate, settle, or enjoin claims against nondebtors that do not affect the debtor’s estate.  In perhaps the final bankruptcy decision of 2009, the Third Circuit rang in the new year with yet another important case--consistent with this general principle-- interpreting the scope of a bankruptcy court's subject matter jurisdiction.  W.R. Grace & Co. v. Chakarian (In re W.R. Grace & Co.), 2009 WL 5151089 (3d Cir. 12/31/09) (pdf).  In it, the Third Circuit both reaffirmed its previous holdings on the limited scope of a bankruptcy court's "related to" jurisdiction and further held that Code section 105(a) does not expand a bankruptcy court's subject matter jurisdiction beyond its statutory boundaries in 28 U.S.C. § 1334(b) (which grants bankruptcy courts "original but not exclusive jurisdiction of all civil proceedings arising under [the Bankruptcy Code] or arising in or related to a case under [the Bankruptcy Code]").

The Third Circuit's seminal opinion in Pacor, Inc. v. Higgins, 743 F.2d 984 (1984), is the most often cited case on the scope of a bankruptcy court's so-called "related to" jurisdiction under 28 U.S.C. § 1334(b). The "Pacor test," which has been nearly universally adopted by federal Courts of Appeal around the country, provides:

[In] determining whether a civil proceeding is related to bankruptcy is whether the outcome of that proceeding could conceivably have any effect on the estate being administered in bankruptcy.  Thus, the proceeding need not necessarily be against the debtor or against the debtor's property.  An action is related to bankruptcy if the outcome could alter the debtor's rights, liabilities, options, or freedom of action (either positively or negatively) and which in any way impacts upon the handling and administration of the bankrupt estate.  Pacor, 743 F.2d 994.

The U.S. Supreme Court, too, looked to Pacor in its first discussion of the scope of a bankruptcy court's "related to" jurisdiction and agreed with Pacor that a bankruptcy court’s "related to" jurisdiction is broad, but "cannot be limitless."  Celotex Corp. v. Edwards, 514 U.S. 300, 308 (1995).

The Third Circuit fine-tuned the Pacor test in In re Federal-Mogul Global, Inc., 300 F.3d 368 (3d Cir. 2002), stating that “[t]he test articulated in Pacor for whether a lawsuit could ‘conceivably’ have an effect on the bankruptcy proceeding inquires whether the allegedly related lawsuit would affect the bankruptcy proceeding without the intervention of yet another lawsuit.”  Id. at 382.  Put another way, there's no "related to" jurisdiction over a third-party claim "if there would need to be another lawsuit before the third-party claim could have any impact on the bankruptcy proceedings."  W.R. Grace, 2009 WL 5151089 at *5 (Op. at 15). 

The Third Circuit further refined the boundaries of the Pacor test in In re Combustion Engineering, Inc., 391 F.3d 190, 225 (3d Cir. 2004), when it held that consideration of additional elements like "unity of interest," "shared production," and "shared insurance" among the debtor and its non-debtor affiliates failed to establish "related to" jurisdiction over third party claims against the non-debtor affiliates "when the third party claim did not directly result in liability for the debtor," but only a potential claim for contribution that "would require the intervention of another lawsuit to affect the bankruptcy estate."  Id. at 231-32.  (Op. at 16-17).

In the recently decided W.R. Grace case, the Third Circuit reaffirmed its holdings in Pacor, Federal-Mogul, and Combustion Engineering, and held that an injunction granted in 2001 (shortly after Grace filed for bankruptcy) against  further prosecution of a lawsuit against Grace for injuries caused by exposure to asbestos at a Montana mine over a 37 year period would not be extended to the State of Montana, who had also been sued by the same plaintiffs for negligence in failing to warn them of the asbestos risks at the mine.  The Montana Supreme Court held that the State of Montana in fact owed the plaintiffs a duty of disclosure of potentially adverse health risks, and so remanded the case back to the trial court for a "determination by the fact-finder of whether the State breached its duty to the [plaintiffs], and if so, whether such breach caused the damages claimed by them."  (Op. at 7).  Grace subsequently moved in the Bankruptcy Court to expand the 2001 injunction to include the plaintiffs' now remanded actions against the State of Montana.  The bankruptcy court refused to so extend the injunction, and the Third Circuit affirmed, holding:

In short, 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. Here, we are presented with state court actions that have only the potential to give rise to a separate lawsuit seeking indemnification from the debtor. Accordingly, we must affirm the Bankruptcy and District Courts' conclusion that subject matter jurisdiction does not exist for the purpose of expanding the § 105(a) injunction to preclude the Montana Actions.  (Op. at 18).

Significantly, the Third Circuit also rejected an alternative ground for expansion of the bankruptcy court's subject matter jurisdiction on the basis that "a bankruptcy court has subject-matter jurisdiction to adjudicate a motion in an adversary proceeding initiated by a debtor in its own bankruptcy case, regardless of the subject matter of that motion."  (Op. at 21).  Citing Celotex, the Third Circuit flatly rejected this opportunity to expand upon the bankruptcy court's subject-matter jurisdiction, stating:

If we were to accept Grace and Montana's position, however, 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 the 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. III and by congressional enactments pursuant thereto."  Delaware v. Van Arsdall, 475 U.S. 673, 692 (1986).  The existence of a bankruptcy proceeding itself has never been and cannot be an all-purpose grant of jurisdiction.

Our conclusion finds support in the Supreme Court's decision in Celotex.  There, the Supreme Court was asked to determine whether a bankruptcy court had jurisdiction to issue a § 105(a) injunction that had the effect of enjoining an action pending in a district court in another judicial district.  Id. at 305.  Rather than assuming that the bankruptcy court's jurisdiction over the adversary proceeding provided it with the necessary jurisdiction to issue the injunction, the Supreme Court observed that bankruptcy court jurisdiction "is grounded in, and limited by, statute."  Id. at 307.  Thus, it explained, the bankruptcy court's jurisdiction to enjoin the other proceeding must be based on the "arising under, arising in, or related to language of §§ 1334(b) and 157(a)."  Id. (quotation marks omitted).  After reviewing several circuit court opinions, including our decision in Pacor, the Supreme Court concluded that the bankruptcy court had jurisdiction to issue the injunction, but only because the proceeding was "related to" Celotex's bankruptcy under the Pacor test.  Id. at 308-10.  If it were the case that a bankruptcy court's jurisdiction over an adversary proceeding was sufficient in and of itself to give it jurisdiction to enjoin third parties, as Grace and Montana now contend, the Supreme Court's entire analysis of related-to jurisdiction in Celotex would have been superfluous.  Clearly it was not.  The Supreme Court undertook the analysis it did because a bankruptcy court may not enjoin proceedings between third parties unless those proceedings arise in or under or are related to the underlying bankruptcy.  Id. at 307.

Thanks for reading, and best wishes for the new year!

© Steve Jakubowski 2010

 
Written By:Steve Sather On January 13, 2010 2:23 PM

The Fifth Circuit has a new case out this week which slightly distinguishes the Third Circuit. Where there is a contractual indemnification clause, there will be related to jurisdiction. Lone Star Fund V (US), LP vs. Barclays Bank, PLC, No. 08-11038 (5th Cir. 1/11/10).

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