Purdue Pharma: Is Protection Of Third Parties By The Automatic Stay An Oxymoron? – Insolvency/Bankruptcy/Re-structuring

The automatic suspension provided for in article 362 of the Bankruptcy Code is an injunction, occurring during the filing of a bankruptcy case, which prevents any procedure or action against the debtor or the property of the mass without judicial authorization – the self- saying “lift the stay”.1

Once the bankruptcy action is initiated, this prohibition extends to all jurisdictions in the United States, including those beyond where the case is filed. The purpose of this provision is to ensure that all such disputes are referred to the bankruptcy court so that they can be judged in accordance with the provisions of the bankruptcy code. We have dealt with interesting cases under 11 USC § 362 in previous customer alerts.2

As a general rule, automatic stay does not extend to non-debtor parties.3 For example, the stay does not prevent the initiation or prosecution of actions against guarantors, debtor company owners, affiliates, debtor partnership partners or co-defendants in pending actions.4

However, as with any rule, there are exceptions. “Specifically, where a particular action against the non-debtor party threatens to interfere with the debtor’s reorganization efforts, courts are prepared to extend section 362 (a) coverage accordingly.”5 In addition, the courts have extended the protection of section 362 when “there is such an identity between the debtor and the third party defendant that the debtor can be regarded as the true defendant and that a judgment against the third party defendant will in effect be be a judgment against the debtor.6However, the courts have warned that these exceptions are rare and have repeatedly stated that the extension of the automatic stay provision to non-debtor parties is “reserved for special circumstances and generally [applies] lawsuits which seriously threaten a reorganization in the form of immediate unfavorable economic consequences for the debtor’s assets. “7

Recently, the issue of extending automatic stay protections to family members who own a debtor business has been a hot topic. Members of the Sackler family, who own Purdue Pharma – the maker of OxyContin – have sought immunity from future opioid lawsuits in exchange for their willful deprivation of control of the bankrupt drug company. Judge Robert Drain, who is presiding over the case in the Southern District of New York8, suggested that a deal of this nature might be achievable in a negotiated settlement that could avoid years of litigation. However, many opponents of this potential ‘deal’ argue that it would set a terrible precedent and strongly argue that the protections afforded to a bankrupt debtor – in particular, the automatic stay protections in Section 362 – should only be extended. ‘to the Sacklers (or any party in a similar situation) when filing their own individual bankruptcy proceedings.

We will continue to monitor the Purdue Pharma matter and all important developments regarding the application of § 362.

Our financial institution and other creditors are urged to be very careful about prosecuting debtors once a case is filed in bankruptcy court. Violating the automatic stay can have serious consequences. However, beyond that, we stand ready to help our creditors clients prevent related party actions in appropriate circumstances.

Footnotes

1.11 USC § 362; Citizens Bank of Maryland v. Strumf, 516 United States 16, 21 (1995)

2. Previous Relevant Legal Alerts from Cullen and Dykman LLP: Automatic stay: even pre-petition seizures can be covered, July 1, 2019; Bank freezes and automatic suspension, July 8, 2019; Yet another court deals with the violation of the automatic stay, September 4, 2019; Automatic stay rapists and prepetition seizures, November 15, 2019; Supreme Court to decide if creditor’s inaction violates automatic stay, December 31, 2019; Watch out for automatic stay! Bankruptcy court sanctions law firm and client for “willful” violation of automatic stay, February 19, 2020; Automatic stay rapists and prepetition seizures, January 20, 2021.

3. See Gucci, America, Inc. v Duty Free Apparel, Ltd., 328 F. Supp. 2d 439 (Bankr. SDNY 2004);
citing Teachers Ins. & Annuity Ass’n v. Butler, 803 F.2d 61, 65 (2d Cir. 1986)

4. See In re: Mohr, 538 BR 882, 888 (Bankr. SD Ga. 2015) [“Although the automatic stay is
extremely broad in scope . it does not extend to separate legal
entities such as corporate affiliates, partners in debtor
partnerships or to codefendants in pending litigation.”
(internal citations and quotations omitted); In re:
Lengacher
, 485 B.R. 380, 383 (Bankr. N.D. Ill. 2012)
(“[The automatic stay provision] does not prevent actions against non-debtor co-obligees, sureties or guarantors of the debtor. “); Gray vs. Hirsch, 230 BR 239, 242 (Bankr. SDNY 1999) (citing the consistent refusal of the Second Circuit to house non-debtor principals as evidence that control of a bankrupt entity does not automatically establish the protection of § 362 (1 ).).

5. Gucci, above., citing
In re: United Health Care Org., 210 BR 228, 232 (Bankr. SDNY 1997); see also In re: North Star Contr. Corp., 125 BR 368, 370-71 (Bankr. SDNY 1991) (extending automatic stay protections to the president of the debtor, where reorganization efforts would be compromised by a state lawsuit against the president of the debtor, given his role active in the reorganization planning process.)

6. In re: United Health Care Org.,
above.

7. Gucci, above.; In re: United Health Care Org., above.; In re: North Star,
above.

8. In re: Purdue Pharma LP Banker. SDNY, case n ° 19-23649 (RDD)

Originally posted May 7, 2021

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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