Restructuring

Contributed by Adam Lavine
The jurisdiction of the bankruptcy court has received a lot of press of late thanks to the Supreme Court’s recent decision in Stern v. Marshall, No. 10-179, 2011 WL 2472792 (U.S. June 23, 2011).  The full implications of Stern will take a long time to be determined.  Of equal legal importance, however, will be the resolution of a different issue related to subject matter jurisdiction – whether courts should apply the “any effects” test or the much narrower “close nexus” test when determining post-confirmation “related to” jurisdiction.
As highlighted by ML Servicing Co., Inc. v. Greenberg Traurig, LLP, No. 11-0832, 2011 WL 3320916 (D. Ariz. Aug. 2, 2011), a recent case from the District of Arizona, not all courts agree on the applicability of the “any effects” test to certain post-confirmation lawsuits brought by a liquidating trust established under a plan.  In ML Servicing, the district court applied the “close nexus” test to a lawsuit commenced by a liquidating trust and rejected what the trust characterized as a growing trend among courts to apply the “any effects” test to lawsuits commenced by a liquidating trust.
In ML Servicing, the ML Liquidating Trust commenced an action against defendants Greenberg Traurig, LLP and Robert Kant.  The complaint asserted state law claims for legal malpractice and breach of fiduciary duty, all stemming from the defendants’ role as the debtor’s securities counsel prior to its bankruptcy.  The debtor’s plan of liquidation established the liquidating trust and granted the trust explicit authority to pursue claims against professionals such as the defendants.  The liquidating trust initially commenced the action in Arizona state court, but the defendants removed the case to the district court citing the district court’s original jurisdiction over matters “related to” bankruptcy cases.  The liquidating trust opposed the removal, filed a motion to remand the case to state court for lack of subject matter jurisdiction, and thus teed up the fight over “related to” jurisdiction.
To determine whether a proceeding “relates to” the main bankruptcy case, courts typically apply the “any effects” test of Pacor, Inc. v. Higgins (In re Pacor), 743 F.2d 984 (3d Cir. 1984).  Under the Pacor test, courts ask “whether the outcome of a proceeding could conceivably have an effect on the estate being administered in bankruptcy.”  Out of fear that bankruptcy court jurisdiction might continue indefinitely under such a broad test, courts have sometimes refused to apply the “any effects” test to post-confirmation matters.  Instead, these courts have applied the “close nexus” test.  Under the “close nexus” test, a bankruptcy court may only exercise “related to” jurisdiction where “there is a close nexus to the bankruptcy plan or proceeding, as when a matter affects the interpretation, implementation, consummation, execution, or administration of a confirmed plan or incorporated litigation trust.”  Binder v. Price Waterhouse & Co. (In re Resorts Int’l, Inc.), 372 F.3d 154 (3d Cir. 2004).
The first issue addressed by the ML Servicing district court was whether to apply the “any effects” test or the “close nexus” test.  Desiring that the case remain in federal court, the defendants argued that the court should apply the broader “any effects” test because the case involved the implementation of a plan of liquidation as opposed to a plan of reorganization.  To support its position, the defendants cited Boston Reg’l Med. Ctr., Inc. v. Reynolds (In re Boston Reg’l Med. Ctr., Inc.), 410 F.3d 100 (1st Cir. 2005), in which the First Circuit held that it need not apply the narrower “close nexus” test when a debtor or trustee commenced litigation pursuant to a liquidating plan.  In Boston Regional, the First Circuit noted two rationales for applying the standard Pacor test to cases involving plans of liquidation.  First, the court reasoned that in the context of a liquidating plan, less danger exists that bankruptcy courts might retain jurisdiction indefinitely because, under a liquidating plan, the debtor’s affairs will be wound up.  Second, the First Circuit noted a key distinction between a reorganized debtor and a liquidating debtor.  A reorganized debtor reenters the marketplace and “attempts to make a go of its business… and its actions (including any involvement in litigation) redound primarily to that end and only affect the underlying bankruptcy proceeding in a tangential or derivative way.”  In contrast, a liquidating debtor’s purpose is to wind up its affairs and execute an order of the bankruptcy court.  Thus, the First Circuit concluded that any litigation involving a liquidating debtor relates more directly to the underlying bankruptcy case.
Applying the rationale of Boston Regional, a number of courts outside of the First Circuit have similarly found that the “any effects” test should apply to cases brought by a liquidating trust formed pursuant to a plan of liquidation.  Such courts include the Southern District of New York, the Eastern District of Kentucky, and the Bankruptcy Court for the District of Maryland.  As reported on this blog, however, courts in Delaware are inclined to apply the “close nexus” test to most post-confirmation matters, including claims brought by a liquidating trust.  See Abigail L. Zigman’s August 18, 2011 blog entry on ACandS, Inc. v. Hartford Accident Indemnity Co. (In re ACandS, Inc.), 2011 WL 744913 (Bankr. D. Del. Feb. 22, 2011) and Deborah Hoehne’s May 12, 2011 blog entry on Logan v. Westchester Fire Insurance Co. (In re PRS Insurance Group, Inc.), 445 B.R. 402 (Bankr. D. Del. 2011).
Without acknowledging this split among jurisdictions, the Arizona district court applied the “close nexus” test to the claims brought by the ML Liquidating Trust because it found the Ninth Circuit’s decision in Montana v. Goldin (In re Pegasus Gold Corp.), 394 F.3d 1189 (9th Cir. 2005) to be controlling.  In Pegasus Gold, the Ninth Circuit applied the “close nexus” test to a case involving a liquidating trust created pursuant to a plan of reorganization.  More specifically, the Pegasus Gold reorganization plan created an environmental reclamation services corporation to perform short-term reclamation work at two of the debtors’ mines and granted a liquidating trust an ownership interest in the reclamation services corporation.  When a dispute arose between the liquidating trust and the state of Montana, the Ninth Circuit applied the “close nexus” test to determine whether the dispute “related to” the bankruptcy case.  In deeming Pegasus Gold controlling, the ML Servicing district court was not persuaded that the creation of the liquidating trust in Pegasus Gold under a plan of reorganization was sufficient to distinguish the case from a liquidating trust created under a plan of liquidation.  Instead, the district court focused on the mere existence of liquidating trusts in both ML Servicing and Pegasus Gold.
Applying the “close nexus” test, the ML Servicing court ultimately held that the trust’s state law claims did not have a “close nexus” to the bankruptcy case sufficient to confer subject matter jurisdiction on the federal court overseeing the case.  To support its holding, the district court noted that it would not be required to interpret the bankruptcy plan in order to resolve the liquidating trust’s claims.  In addition, the district court rejected the trusts’ argument that “related to” jurisdiction should exist when an action has potential to increase recovery to the creditors.  Accordingly, the district court remanded the case back to state court.
ML Servicing reminds us that the law governing post-confirmation “related to” jurisdiction may vary significantly from jurisdiction to jurisdiction.  This lesson is an important one.  A court’s decision to apply the “close nexus” test over the broader “any effects” test has significant potential to foreclose venue options for the prosecution and defense of post-confirmation litigation.  Although the S.D.N.Y. and other courts still embrace the “any effects” test for post-confirmation jurisdiction,  the Arizona district court has joined with Delaware to apply the “close nexus” test to any post-confirmation action brought by a liquidating trust pursuant to a plan of liquidation.