• Automatic Stay Extended to Action against NonDebtor where Debtor Obligated to Indemnify NonDebtor
  • July 15, 2004
  • Law Firm: Weil, Gotshal & Manges LLP - Office
  • In W.R. Grace & Co. v. Chakarian et al. (In re W.R. Grace & Co.), the United States Bankruptcy Court for the District of Delaware recently held that the automatic stay applied to a lawsuit against a nondebtor where the debtor was contractually obligated to indemnify the nondebtor and the lawsuit, therefore, directly impacted the debtor's reorganization proceedings. As a consequence, the plaintiff was barred from continuing to prosecute its lawsuit against the nondebtor.

    Sections 362 and 105 of the Bankruptcy Code

    Section 362(a) of the Bankruptcy Code provides in relevant part that the filing of a bankruptcy petition "operates as a stay . . . of -- (1) the commencement or continuation . . . of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title." Additionally, section 105(a) of the Bankruptcy Code provides in relevant part that "[t]he court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title."

    While pre-bankruptcy litigation against a debtor is clearly suspended by the automatic stay, courts have struggled to determine when, if ever, litigation against a nondebtor may be suspended by the automatic stay. At issue before the bankruptcy court in W.R. Grace was whether the automatic stay applied to a state court action against a third party when the action was not an action "against the debtor" governed by the language of section 362(a)(1). The bankruptcy court held that the state court action was stayed under sections 362(a)(1) and 105(a) of the Bankruptcy Code.

    Factual Background

    From 1979 through 1985, Grace Petroleum Company ("GPC"), then a subsidiary of current debtor Grace Energy Company ("GEC"), held exploration rights to Cushing Field in Oklahoma. In 1985, GPC sold its exploration rights to Cushing Field to ExxonMobil. Pursuant to the sale, GPC agreed to indemnify ExxonMobil for damages relating to GPC's operations at Cushing Field. In 1992, GEC sold GPC to Samson Hydrocarbons Co. ("Samson"). Pursuant to the sale, GEC agreed to indemnify Samson for liabilities relating to facilities GPC had previously owned.

    Beginning in 1990, several landowners asserted claims against ExxonMobil alleging groundwater contamination and surface damage relating to the operations at Cushing Field. ExxonMobil settled those claims and subsequently requested indemnity for the settlement amounts from Samson, the owner of GPC. When Samson refused to indemnify ExxonMobil, ExxonMobil commenced an action against Samson for indemnity and contribution in Oklahoma State Court in June 1997 (the "Oklahoma Action"). Pursuant to GEC's agreement to indemnify Samson, GEC assumed the defense of the Oklahoma Action.

    On April 2, 2001, GEC and certain affiliates filed voluntary petitions under chapter 11 of the Bankruptcy Code. On June 21, 2001, the debtors filed a complaint seeking to enjoin certain prepetition litigation that allegedly implicated the debtors, including the Oklahoma Action. In response, ExxonMobil filed a motion for summary judgment asserting that there was no basis for enjoining the Oklahoma Action, as the debtors were not a party thereto.

    The Bankruptcy Court's Decision

    In considering the scope of the automatic stay, the bankruptcy court first noted that despite the language providing that section 362(a)(1) applies to actions "against the debtor," courts have consistently held that the automatic stay can be extended to actions that are essentially, although not technically, against a debtor or that would interfere with a debtor's reorganization proceedings. The court stated that such an application of section 362(a) is consistent with Congress's intent "to cease creditor collection efforts of antecedent debts, to protect assets of the debtor's estate, to provide for the equitable treatment of all creditors and to ensure successful reorganization efforts." On the other hand, the court noted that courts are cautious about extending the automatic stay beyond actions against the debtor and are inclined to extend the automatic stay to actions against third parties only in the "most extreme and unusual circumstances" where "there is such an identity between the debtor and the third-party defendant that the debtor may be said to be the real party defendant" such that "a judgment against the third-party defendant will in effect be a judgment or finding against the debtor."

    ExxonMobil argued that because the Oklahoma Action was based on a contractual obligation to which the debtor GEC was not a party, there was no identity between the debtor and the third-party defendant Samson and, therefore, the automatic stay should not apply to the Oklahoma Action. The bankruptcy court disagreed. It noted the fact that the debtor was not named as a defendant in the Oklahoma Action was not dispositive. Although ExxonMobil had pursued its claims against Samson, Samson was entitled to indemnification from the debtors. Thus, the bankruptcy court concluded that "unusual circumstances" existed in this case because a judgment against Samson would, in effect, be a judgment against the debtor.

    The bankruptcy court further noted that because only GPC's operations, not Samson's operations, constituted the basis for ExxonMobil's claims, there was no possibility that Samson would choose not to pursue indemnification from GEC. The bankruptcy court rejected ExxonMobil's arguments that GEC's obligations under the indemnity agreement were not absolute, and that "therefore, the automatic stay should not be extended to the Oklahoma Action." The court observed that GEC already acknowledged prepetition that the Oklahoma Action was covered by its indemnity agreement with Samson and assumed the defense of the Oklahoma Action.

    Additionally, the bankruptcy court also held that the extension of the automatic stay was warranted under section 105(a) of the Bankruptcy Code, as continuation of the Oklahoma Action would directly impact the debtors' reorganization proceedings. Because of the debtors' indemnity obligations, the debtors would be required to expend time and resources defending the Oklahoma Action if it were permitted to continue. These expenses would deplete the debtors' assets, thus impairing their quest for a successful reorganization. The court concluded that a stay of the Oklahoma Action was appropriate given these circumstances.

    Conclusion

    The decision in W.R. Grace is significant because it provides another example of a court extending the automatic stay to an action against a nondebtor. The dispute over the scope of the automatic stay is common in bankruptcy cases. The debtor often attempts to persuade the bankruptcy court to extend the automatic stay to a variety of actions that directly and indirectly affect the debtor. Conversely, creditors unable to pursue remedies against the debtor due to the chapter 11 filing often attempt to collect from other sources and are frustrated by the extension of the automatic stay to such collection efforts. In Delaware, it will be important for creditors to bear in mind the holding in W.R. Grace before commencing or continuing litigation against nondebtor, third parties where such litigation may impact a debtor's reorganization and, thus, be stayed by a court.

    W.R. Grace & Co. v. Chakarian (In re W.R. Grace & Co.), No. 01-01139 (JFK), Adv. A-01-771, 2004 Bankr. LEXIS 579 (Bankr. D. Del. Apr. 29, 2004).