Extra Protection: Bankruptcy Court Extends Automatic Stay to Cover Non-Debtor Affiliate in Arbitration Proceeding

Contributed by Laura Napoli
In In re Brier Creek Corp. Center Assocs. LP, the United States Bankruptcy Court for the Eastern District of North Carolina examined an issue that might be on the minds of many debtors involved in litigation or arbitration: when can the automatic stay be extended to protect not only the debtor, but also a non-debtor third party?
The debtor, Brier Creek Corporate Center Associates, operated an office park within a mixed residential/commercial/retail community in North Carolina.  In October 2011, Brier Creek and its affiliates sued Bank of America in North Carolina state court in connection with loans the bank had made to Brier Creek and its affiliates.  Five months later, in March 2012, Brier Creek filed for bankruptcy, and in May of 2012, Brier Creek removed the state court litigation to the bankruptcy court and commenced an adversary proceeding against Bank of America.
In December 2012, Bank of America filed a demand for arbitration against the officers of American Asset Corporation (“AAC”), one of the plaintiffs in the state litigation and an affiliate of Brier Creek.  AAC was the property manager for Brier Creek, overseeing the management and development of Brier Creek’s properties on a day-to-day basis.  In January 2013, Brier Creek filed a motion in the bankruptcy court seeking to stay the arbitration brought by Bank of America against AAC’s officers and to enjoin Bank of America from proceeding with its arbitration demand.
Procedural Arguments
Bank of America first argued that Brier Creek did not follow the proper procedures in bringing the motion, asserting that Brier Creek should have commenced an adversary proceeding instead.  Reviewing Brier Creek’s motion, the court determined that the debtor was seeking relief on two grounds: an extension of the automatic stay to the AAC defendants under section 362(a)(1) of the Bankruptcy Code and an injunction prohibiting the arbitration under section 105(a) of the Bankruptcy Code.  Although the court acknowledged that seeking a determination that the automatic stay applies is properly made by motion, it found that a request for an injunction must ordinarily be sought by adversary proceeding.  Nevertheless, the court found that the interests of judicial economy permitted it to address the merits of whether an injunction should be granted even though Brier Creek technically should have commenced an adversary proceeding.  The court was further persuaded to disregard any procedural errors by the fact that Bank of America would not be prejudiced because the court previously had addressed whether it had jurisdiction over the issue, no bond needed to be posted by Brier Creek, and Brier Creek’s counsel previously had made an oral motion in the existing adversary proceeding against Bank of America requesting a stay of the arbitration.
Extension of the Stay
The court next turned to the question of whether the automatic stay could be extended to a third party, in this case the AAC officers.  Looking to the Fourth Circuit for guidance, the court identified a narrow exception to the general rule that the automatic stay only applies to debtors: in “unusual circumstances,” the stay can be extended.  When are circumstances “unusual” enough to warrant an extension of the stay?  In A.H. Robins Co. v. Piccinin, the Fourth Circuit provided some examples. A suit against a third party who is entitled to absolute indemnity by the debtor would be grounds for extending the stay, as well as a suit where the debtor’s guarantor is sued along with the debtor.  In Credit Alliance Corp. v. Williams, however, the Fourth Circuit made it clear that not every guaranty case warranted extending the automatic stay to protect non-debtors.  Instead, something “unusual” about the guaranty agreement must exist to justify extension of the automatic stay.
After examining these cases in some depth, the bankruptcy court next sought to determine what would constitute an “unusual” relationship.  The court came up with the following examples: when allowing the litigation to continue against the non-debtor would threaten the debtor’s ability to fund a feasible reorganization plan; where the non-debtor is deeply intertwined in the debtor’s bankruptcy; or when the underlying bankruptcy case is at a “critical juncture” that would require the non-debtor’s participation.
The court found that all three of these examples were appropriate in the instant case.  Because the AAC officers played an integral role in Brier Creek’s day-to-day operations, the court found that prosecution of the arbitration against them would have significant effects on Brier Creek’s ability to reorganize successfully.  The bankruptcy case was also at a “critical juncture” because confirmation hearings were scheduled to occur in less than two months.  Finally, the court found that Brier Creek’s reorganization depended on financing from AAC and its affiliates and that litigation against AAC and its officers would detrimentally affect AAC’s underwriting assessment, possibly threatening Brier Creek’s ability to maintain sufficient financing for its plan.
The court found that these circumstances also justified granting Brier Creek a preliminary injunction.  The court concluded that the arbitration was a significant threat that would thwart or frustrate Brier Creek’s reorganization efforts.  Finding that an injunction was important for an effective reorganization, the court extended the automatic stay to AAC and issued an injunction against the arbitration proceedings.
Although the determination of whether the automatic stay can be extended to a non-debtor third party is often very fact-specific, the bankruptcy court’s decision here provides some good examples of what circumstances would warrant an extension of the stay.