Delaware Business Bankruptcy Report : Delaware Business Bankruptcy Report : Morris James LLP Lawyers & Attorneys

The Libby Claimants had commenced suit against the State of Montana prior to Grace’s bankruptcy filing on the basis that the State of Montana was negligent in failing to warn the Libby Claimants of the dangers of asbestos from the Libby mine. Montana originally sought stay relief from the bankruptcy court to file third-party claims against Grace. Grace opposed the motion for relief, but filed a motion of its own, seeking to impose a stay, of the Libby Claimants’ actions against Montana under Section 105(a). Grace proposed that allowing the continuation of suits against Montana would impede Grace’s ability to reorganize.

The Bankruptcy Court denied the relief requested by Grace, and held that under existing precedent interpreting 28 U.S.C. §§ 1334(b) and 157(a), the Court did not have subject matter jurisdiction to enter such a stay. In particular, the Bankruptcy Court held that “Montana must first be found liable in state court and then pursue its claim for indemnification in bankruptcy court . . . . A judgment against the State of Montana will not bind Debtors. An intervening action is necessary to affect the estate.” On appeal, the District Court affirmed under the same rationale.

On subsequent appeal to the Third Circuit, Grace and Montana argued that “a federal court need not have jurisdiction over a state-court action in order to enjoin it.” The Third Circuit rejected this view, noting under existing case law, even the broad language of Section 105(a) “does not provide an independent source of federal subject matter jurisdiction.” Rather, subject matter jurisdiction is the “threshold jurisdictional inquiry” before an injunction may issue under 105(a).

While acknowledging that “proceedings over which a bankruptcy court can legitimately exercise related-to jurisdiction include suits between third parties that conceivably may have an effect on the bankruptcy estate,” the Third Circuit carefully parsed the language of “any conceivable effect” and found that it had a much more narrow focus based upon the Court’s own decision in Pacor, Inc. v. Higgins, 743 F.2d 984 (3d Cir. 1984).

In Pacor, the Third Circuit denied removal of a claim by Higgins against Pacor to the Bankruptcy Court overseeing the Johns-Manville bankruptcy. In refusing to allow removal, the Third Circuit noted that “the primary action between Higgins and Pacor would have no effect on the Manville bankruptcy estate.” Accordingly, there was no related-to jurisdiction. Rather, the Court stated that the Higgins-Pacor action “is a mere precursor to the potential third-party claim for indemnification by Pacor against Manville. Yet the outcome of the Higgins-Pacor action would in no way bind Manville . . . .”

In the instant case, the Third Circuit also quoted from its decision in Federal-Mogul Global, Inc., 300 F.3d 368 (3d Cir. 2002) where it reaffirmed Pacor, stating expressly that “whether a lawsuit could ‘conceivably’ have an effect on the bankruptcy proceeding . . . [demands inquiry into] whether the allegedly related lawsuit would affect the bankruptcy proceeding without the intervention of yet another lawsuit.” Moreover, the Third Circuit cited its more recent decision in In re Combustion Eng’g, Inc., 391 F.3d 190 (3d Cir. 2004) where it again reaffirmed Pacor’s and Combustion’s statement of “related-to” jurisdiction.

Applying the Pacor test to the Grace facts, the Court stated: “Grace will not be bound by any judgment against [Montana]. Rather, an entirely separate action would be necessary for any liability incurred by Montana to have an impact on Grace’s estate. Specifically, Montana would first have to be found liable by its state courts and would then have to successfully bring an indemnification or contribution claim against Grace in the bankruptcy court. This is precisely the situation in which we have found that related-to jurisdiction does not exist.”

Finally, the Third Circuit rejected several other arguments made by Grace and Montana. It denied any “unity of interest” argument on the basis that Montana’s potential liability was based not on a unity of interest, but on an alleged independent legal duty owed by Montana to the Libby Claimants. The Court also denied that its decision was governed by ‘law of the case’ arising from a non-precedential opinion issued by the Court in connection with earlier Grace proceedings. First, the Court distinguished the earlier opinion, but also noted that there was no identity of parties and issues. Thus, the law of the case doctrine did not apply.

For a discussion of the underlying bankruptcy court opinion, click here.