In re Excel Innovations, Inc.

• Decision Date: 07 September 2007
• Docket Number: No. 06-17288.,06-17288.
• Citation: 502 F.3d 1086
• Parties: In re EXCEL INNOVATIONS, INC., Debtor, Solidus Networks, Inc.; Indivos Corporation, Appellants, v. Excel Innovations, Inc.; Ned Hoffman, Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

502 F.3d 1086

In re EXCEL INNOVATIONS, INC., Debtor,

Solidus Networks, Inc.; Indivos Corporation, Appellants, v. Excel Innovations, Inc.; Ned Hoffman, Appellees.

No. 06-17288.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted June 11, 2007.

Filed September 7, 2007.

Kristen A. Palumbo, Alfred C. Pfeiffer, Jr., Bingham McCutchen LLP, San Francisco, CA, for the appellants.

Scott L. Goodsell, Campeau Goodsell Smith, San Jose, CA, for appellee Excel Innovations; John T. Hansen, Nossaman, Guthner, Knox & Elliott, San Francisco, CA, for appellee Hoffman.

Appeal from the Ninth Circuit Bankruptcy Appellate Panel; Alley, Smith, and Marlar, Bankruptcy Judges, Presiding. BAP No. NC-05-01510-MaSA1.

Before: ALFRED T. GOODWIN, JAY S. BYBEE, and MILAN D. SMITH, JR., Circuit Judges.

GOODWIN, Senior Circuit Judge:

Debtor Excel Innovations, Inc. ("Excel") applied for a preliminary injunction staying arbitration proceedings between two non-bankrupt parties, Indivos Corporation ("Indivos") and former Excel CEO Ned Hoffman ("Hoffman"). The bankruptcy court granted the injunction, finding a reasonable probability that the arbitration could conceivably affect the debtor and the bankruptcy estate. The Bankruptcy Appellate Panel ("BAP") affirmed. The present appeal followed.

We hold that when a debtor applies for a 11 U.S.C. § 105(a) preliminary injunction to stay a proceeding in which the debtor is not a party, the bankruptcy court must balance the debtor's likelihood of success in reorganization against the relative hardship of the parties, as well as consider the public interest if warranted. Because the bankruptcy court misapprehended the operative legal standard, we reverse and remand for further proceedings.

I. BACKGROUND

Hoffman is the founder and a major shareholder of both Indivos and Excel. In 2000, Hoffman entered into a series of agreements ("Settlement Contracts") with Indivos. These included the Settlement Agreement and General Release, the Voting Trust and Standstill Agreement, the Pledge Agreement, and the Proprietary Information and Inventions Agreement. One of the main purposes of these agreements was to separate Hoffman from the management of Indivos. Excel, which was controlled by Hoffman and separately owned Indivos shares, was not a party to the Settlement Agreement or the Pledge Agreement. However, Excel was a party to the Voting Trust and Standstill Agreement, which required Hoffman and Excel to place their Indivos shares in a voting trust as collateral for their obligations under the Settlement Contracts. Section 9(a) of the Voting Trust and Standstill Agreement, which applied to Hoffman only, prohibited him from "individually or with others, directly or indirectly," taking any action to "control, disrupt, or unduly influence the management or policies of [Indivos]." The parties agreed to submit any dispute arising from the Settlement Contracts to binding arbitration with the American Arbitration Association ("AAA").

In June 2003, Indivos initiated AAA arbitration proceedings against Hoffman and Excel. Indivos alleged that Hoffman and Excel attempted to disrupt a merger between Indivos and Solidus Networks, Inc. ("Solidus") by, inter alia, filing multiple shareholder derivative actions, initiating a proxy contest, and attempting to gain a seat on the Indivos board. Indivos also alleged that Excel and Hoffman filed a patent infringement action against Indivos in the Northern District of California in violation of the Proprietary Information and Inventions Agreement. Indivos claimed that it, not Excel, owned the patents at issue. Indivos pled seven claims for relief, including breach of the Settlement Contracts, unfair business practices, and breach of fiduciary duty by Hoffman. Indivos also sought to hold Excel liable as Hoffman's alter ego.

On May 14, 2004, the arbitrator granted partial summary judgment for Indivos, finding Hoffman liable for breach of contract because he filed lawsuits to disrupt the merger, urged shareholders to vote against the merger, and tried to get on the Indivos board. The arbitrator found Excel liable as Hoffman's alter ego for some of the lawsuits Excel filed under Hoffman's direction, but denied summary judgment as to other lawsuits filed by Excel. The arbitrator further denied summary judgment with respect to merger-disrupting actions undertaken by two alleged surrogates of Hoffman. The arbitrator postponed any determination of the parties' patent rights, including whether their positions on patent ownership were taken in good faith, until resolution of the patent litigation in federal district court. The arbitrator also dismissed without prejudice Indivos' unfair business practices claim.¹ Less than a week later, the arbitrator began hearings on the remaining claims and damages.

In late May 2004, Excel and Hoffman suffered a significant setback in their patent infringement action against Indivos. Judge Chesney of the Northern District of California granted partial summary judgment for Indivos, ruling that all of the patents Excel accused Indivos of infringing were actually owned by Indivos.

In June 2004, Hoffman and Excel filed bankruptcy petitions under Chapter 13 and Chapter 11, respectively. The bankruptcy filings automatically stayed the arbitration against Hoffman and Excel, as well as the patent litigation. See 11 U.S.C. § 362(a). At that point in the arbitration, Indivos and Solidus had concluded their affirmative case, Hoffman and Excel had presented a substantial part of their defense, and the parties were attempting to schedule additional hearing dates to finish the proceeding. Hoffman's bankruptcy petition was dismissed in September 2004. In December 2004, Hoffman resigned as an officer and director of Excel.

In February 2005, Indivos recommenced arbitration against Hoffman, on the ground that the stay established by Hoffman's bankruptcy petition had been lifted. Hoffman argued to the arbitrator that the stay established by Excel's bankruptcy petition applied to Indivos' claims against him because those claims were intertwined with Indivos' claims against Excel. The arbitrator disagreed. The arbitrator stated that any claims that alleged direct or alter ego liability for Excel remained subject to the stay, but claims involving only Hoffman could proceed. The arbitrator did not schedule further evidentiary hearings and asked Hoffman and Indivos to submit closing briefs by July 29, 2005.

In July 2005, Excel initiated adversary proceedings in bankruptcy court against Indivos, Solidus, Hoffman, AAA, and the arbitrator. Excel sought declaratory and injunctive relief on the ground that the arbitration violated the automatic stay in Excel's bankruptcy case. According to Excel, Hoffman might argue that he acted as Excel's agent, leading to new liabilities for Excel and the bankruptcy estate. On the same day, Excel applied for a temporary restraining order ("TRO") to stop the arbitration. To reassure the court that the arbitration would not affect Excel, Indivos and Solidus stipulated that the arbitration would have no preclusive effect on Excel; that damages against Hoffman would not be offset against the Indivos shares Excel had pledged to the voting trust; and that to avoid privilege issues, no further evidence would be presented in the arbitration proceeding. The bankruptcy court denied the TRO on the basis of these representations.

Hoffman then wrote to AAA to request changes to the briefing schedule so he could present additional evidence. The arbitrator agreed. Hoffman immediately filed an ex parte application to reopen Excel's motion for a TRO and preliminary injunction. Counsel argued that, because the arbitrator now planned to take additional evidence, one of the bases for denying the injunction — Indivos' agreement not to present additional evidence — was no longer present. The bankruptcy court entered a TRO. The court expressed concern that information subject to Excel's attorney-client privilege could be revealed by Hoffman in the arbitration proceeding.

In September 2005, Excel filed a motion for a preliminary injunction. The motion was supported by an affidavit from Hoffman. He had served as Excel's CEO during the events that gave rise to Indivos' claims, but at this time was only a consultant for Excel. In the affidavit, Hoffman offered three reasons why permitting arbitration against him would adversely impact Excel. First, he planned to demand indemnification from Excel on the ground that he was acting as an officer and agent of Excel when he challenged the Solidus-Indivos merger. Thus, arbitration could lead to new liabilities for Excel. Second, his defense would focus on his own interests and not those of Excel. Third, he would be "compelled to reveal the substance of critical privileged communications between myself and attorneys for the Debtor," because he acted "in accordance with legal advice from attorneys for the Debtor." He also intended to call Excel employees as witnesses.

The bankruptcy court granted an injunction staying arbitration until confirmation of Excel's reorganization plan. The court stated that a § 105(a) injunction is proper if arbitration "could conceivably have any effect on the administration of the bankruptcy estate." The court decided that Excel established a "reasonable probability" of possible negative impacts on the estate. Moreover, the court found that Excel's motion also satisfied the traditional, non-bankruptcy test for a preliminary injunction, which "balances the plaintiff's likelihood of success [on the merits] against the relative hardship to the parties." See Clear Channel Outdoor Inc. v. City of Los Angeles, 340 F.3d 810, 813 (9th Cir.2003). The bankruptcy court made no findings on plaintiff's likelihood of success, but concluded that a stay would protect Excel from possible injury while causing no harm to Indivos and Solidus.

Indivos and Solidus appealed to the BAP,...