The Benefits of Bankruptcy

No diversity, no federal question, no federal court, right?  Not necessarily.  An important, but often times unavailable, basis for federal court jurisdiction arises when a defendant files for bankruptcy protection, thereby allowing its co-defendants to remove claims that are “related to” the bankruptcy.  This can provide a huge strategic advantage to a debtor’s co-defendants, particularly in the product liability context where the forum defendant rule often prevents defendants from seeking removal based on diversity.  Under such a scenario, a non-debtor co-defendant may have the ability to remove a once non-removable case to federal court.

To invoke this bankruptcy jurisdiction, a defendant must engage in a two-step process.  First, a defendant must remove the state court case to the federal court where the action was pending, pursuant to 28 U.S.C. §§ 1452 and 1334, which provide federal district courts with original, but not exclusive, jurisdiction of all civil proceedings arising under title 11 or arising in or related to cases under title 11. 

Once a defendant properly removes the state court case to federal court, it can then seek to have the case transferred to the bankruptcy court’s district.  Such a transfer would permit that district court to determine the appropriate venue, either itself or the district court to which the case was originally removed.  According to 28 U.S.C. § 157(b)(5):

“The district court shall order that personal injury tort and wrongful death claims shall be tried in the district court in which the bankruptcy is pending, or in the district court in the district in which the claim arose, as determined by the district court in which the bankruptcy case is pending.”

The phrase “related to” is not defined in the Bankruptcy Code though most federal courts have determined that the test for determining whether a case is “related to” a bankruptcy proceeding is “whether the outcome of the proceeding could conceivably have any effect on the estate being administered.”  See Pacor v. Higgins, 734 F.2d 984, 994 (3d Cir. 1994).  An action is “related to bankruptcy if the outcome could alter the debtor’s rights, liabilities, options, or freedom of action (either positively or negatively) and which in any way impacts upon the handling and administration of the bankruptcy estate.”  Id.  A proceeding “need not necessarily be against the debtor or against the debtor’s property” to satisfy the requirements for “related to” jurisdiction.  Id.  However, “the mere fact that there may be common issues of fact between a civil proceeding and a controversy involving the bankruptcy estate does not bring the matter within the scope of section [1334(b)].”  Id.  Instead, “there must be some nexus between the ‘related’ civil proceeding and the title 11 case.”  Id.

Courts have considered the following factors in determining “related to” jurisdiction in the mass tort context.

  • Whether the co-defendant has a claim against the debtor for contribution and/or indemnification.  “Claims for indemnification and contribution, whether asserted against or by [the debtor], obviously would affect the size of the estate and the length of time the bankruptcy proceedings will be pending, as well as [debtor’s] ability to resolve its liabilities and proceed with reorganization.”  Dow Corning Corp. v. O’Brien et al, 86 F.3d 482, 495 (6th Cir. 1996) (reversing denial of motion to transfer breast implant personal injury cases under “related to” bankruptcy jurisdiction); but see In re Federal-Mogul Global, Inc., 300 F.3d 368 (3d Cir. 2002) (declining to reverse district court’s denial of transfer of thousands of personal injury and wrongful death actions as “related to” debtor’s bankruptcy where indemnifications claims were only contingent and had not yet matured).
  • Whether plaintiffs’ claims implicate joint conduct of the debtor and non-debtor co-defendants.  “When a plaintiff alleges liability resulting from the joint conduct of the debtor and non-debtor defendants, bankruptcy jurisdiction exists over all claims under section 1334.”  In re Wood, 825 F.2d 90, 94 (5th Cir. 1987).
  • Whether the debtor and non-debtor co-defendants have jointly held insurance policies.  See, e.g. A.H. Robins Co., 788 F.2d 994, 1008 (4th Cir. 1986) (finding that where debtor and co-defendant had jointly held insurance policies “irreparable harm would be suffered by the debtor and by the defendants since any of [the] suits against [the] co-defendants, if successful, would reduce and diminish the [debtor’s] insurance fund”).
  • Whether there is a “unity of identity” between the debtor and non-debtor co-defendants.  See In re Federal-Mogul Global, Inc., 300 F.3d at 383 (discussing the need to evaluate the relationship between the defendant and debtor when evaluating the appropriateness of “related to” jurisdiction).

Co-defendants of a bankrupt debtor in a mass tort action have had mixed success attempting to secure “related to” jurisdiction of their claims, in part because courts are reluctant to prejudice plaintiffs and deny them their choice of forum simply because a defendant filed for bankruptcy.  However, removal, even if it will almost certainly result in remand, may be strategically advantageous to a defendant to delay discovery and foster settlement negotiations.