In re Arrow Huss, Inc.

• Decision Date: 01 August 1985
• Docket Number: Bankruptcy No. 84C-03187.
• Parties: In re ARROW HUSS, INC., a Delaware corporation, Debtor.
• Court: United States Bankruptcy Courts. Tenth Circuit. U.S. Bankruptcy Court — District of Utah

51 B.R. 853 (1985)

In re ARROW HUSS, INC., a Delaware corporation, Debtor.

Bankruptcy No. 84C-03187.

United States Bankruptcy Court, D. Utah.

August 1, 1985.

Noel S. Hyde, Nielsen & Senior, Salt Lake City, Utah, for debtor.

MEMORANDUM OPINION

GLEN E. CLARK, Bankruptcy Judge.

FACTUAL AND PROCEDURAL BACKGROUND

The debtor, Arrow Huss, Inc., is engaged in the design, manufacture, sale and maintenance of amusement rides. The debtor was incorporated in 1981 and is a leader in that industry. The debtor suffered substantial financial losses on attractions constructed for the 1984 New Orleans World Fair as a result of unexpectedly low visitor attendance.

On November 20, 1984, an involuntary Chapter 11 petition was filed against the debtor and an order for relief was entered on December 18. Prior to the filing of the involuntary petition, several officers and employees of the debtor incurred debts on behalf of the debtor, including credit card charges for corporate business expenses, medical expenses to be paid through the company's employee benefit plan, and travel and moving expenses incurred at the request of the debtor. The debtor acknowledges liability for these claims.

After entry of the order for relief, credit card companies began contacting several officers and employees requesting payment of the charges from them individually. On January 11, 1985, the debtor filed a motion to extend the protection of the automatic stay to its present officers and employees with respect to claims which might be asserted against them individually, and requested a hearing on five days notice to all creditors and parties in interest.¹ The Court entered an order reducing the time for notice and the matter was heard on January 17, 1985.

At the hearing, the debtor's attorney made a proffer that if the officers and employees were required to defend against these collection actions, some would terminate their employment with the debtor and others would be unable to devote the necessary time and attention to the reorganization effort.² Counsel argued that without injunctive relief, the debtor's attempts to reorganize under Chapter 11 would be severely jeopardized. No creditor appeared in opposition to the motion.

The Court was concerned about the limited notice and the breadth of the injunction sought, but believed the debtor made a sufficient showing of hardship to justify temporary relief. Accordingly, the Court determined that collection efforts on the above-described obligations against present officers and employees of the debtor should be enjoined for a period of 45 days. But the injunction was subject to being vacated or modified within that time upon motion of a party in interest, and any extension of the injunction beyond 45 days would require a further evidentiary hearing on 20 days notice to parties in interest.

The exigent circumstances of the case required that the Court rule from the bench, but the Court reserved the right to issue a memorandum opinion elaborating upon the basis for its ruling.

DISCUSSION

This proceeding presents a problem often found in Chapter 11 cases. Because the creditor cannot reach the debtor who is protected by the automatic stay, it proceeds against the principals of the debtor who stand as guarantors, co-obligors, or sureties. Those individuals must divert their energies from the reorganization effort to defending themselves in the litigation. The principal question to be decided is whether and to what extent the bankruptcy court may exercise its injunctive power under Section 105(a),³ in effect, to extend the protection of the automatic stay to the debtor's officers and employees during the pendency of a Chapter 11 case.

It is well settled that Section 362 of the Bankruptcy Code, which stays actions against the debtor and against property of the estate, does not forbid actions against its nondebtor principals, partners, officers, employees, co-obligors, guarantors, or sureties.⁴ The legislative history shows that Congress may have considered the issue of a general stay of actions against guarantors in reorganization cases,⁵ but apparently rejected such a blanket stay and limited co-debtor stays to Chapter 13. See 11 U.S.C. § 1301. As enacted, Chapter 11 contains no specific provision authorizing stays against nondebtor codefendants.⁶ Therefore, the sole statutory basis for the issuance of an injunction against these collection efforts is Section 105.⁷ Under this provision, bankruptcy courts have used the injunctive power to provide temporary protection to co-obligors during the pendency of a Chapter 11 case. See, e.g., In re Equity Funding Corp. of America, 396 F.Supp. 1266 (C.D.Cal.1975) (enjoining actions against the debtor's wholly-owned subsidiaries, which would frustrate the ability of the court to reorganize the debtor or proceed with the plan of reorganization); In re Otero Mills, Inc., 21 B.R. 777 (Bkrtcy.D.N.M.) aff'd, 25 B.R. 1018, 9 B.C.D. 1400 (D.C.D.N.M.1982) (creditor temporarily enjoined from foreclosing against property of the debtor's president in execution of judgment arising from personal guaranties of debtor's promissory notes); In re Original Wild West Foods, Inc., 45 B.R. 202, 11 C.B.C.2d 1447 (Bkrtcy. W.D.Texas 1984) (IRS enjoined from collecting 100% tax penalty for unpaid prepetition withholding and employment taxes from an officer, director and shareholder of the Chapter 11 debtor); In re Lion Capital Group, 44 B.R. 690 (Bkrtcy.S.D.N.Y.1984) (bankruptcy court enjoined continuation of fraud-based suits brought by limited partners against principals, parent companies and general partners involved with the debtor's Chapter 11 case); In re Sondra, Inc., supra, 44 B.R. at 205 (bankruptcy court lacks jurisdiction to stay creditor from state court action against one of the debtor's principals unless it finds that failure to enjoin would detrimentally affect the estate and would adversely pressure the debtor through that principal); In re Ms. Kipps, Inc., 34 B.R. 91 (Bkrtcy.S.D.N.Y. 1983) (bankruptcy court enjoined union from state court action against the debtor's president for failure to make employee benefit contributions where the action was inextricably intertwined with claims against the debtor, and the president would be detracted from his efforts to operate and rehabilitate the debtor's business); In re Johns-Manville Corp., supra, 26 B.R. at 420 (bankruptcy court temporarily stayed all suits and discovery requests against 25 key officers, directors, employees and agents who are essential to plan formation and reorganization); Matter of Johns-Manville Corp., 26 B.R. 405, 416 (Bkrtcy.S.D.N. Y.1983) aff'd 40 B.R. 219 (D.C.S.D.N.Y. 1984) (Section 105 permits bankruptcy court to enjoin creditor's action against third party co-debtor or guarantor where proper showing is made); In re Comtek Electronics, Inc., 23 B.R. 449 (Bkrtcy.S.D. N.Y.1982) (bankruptcy court lifted preliminary injunction and allowed bank to proceed with state court action against nondebtor guarantor of promissory notes); In re Landmark Air Fund II, 19 B.R. 556, 9 B.C.D. 3 (Bkrtcy.N.D.Ohio 1982) (bankruptcy court declined to enjoin bank from foreclosing on assets of the debtor's general partners to enforce judgment where the debtor intended to liquidate rather than reorganize); First Federal Savings & Loan Association v. Pettit, 12 B.R. 147, 7 B.C.D. 731 (E.D.Ark.1981) (affirming an order enjoining action against the debtor's mother-in-law and her husband who co-signed mortgage and promissory note on a personal residence where "such an action might place pressure on the bankrupt and ultimately affect the proposed reorganization"); In re Larmar Estates, Inc., 5 B.R. 328, 6 B.C.D. 711 (Bkrtcy.E.D.N.Y.1980) (bankruptcy court permitted FDIC to enforce state court judgment against individual guarantors where guarantors could not show that action would impair the debtor's chances for successful reorganization).

In extraordinary cases, and under limited circumstances, the exercise of this power is necessary and appropriate to effect the objectives of Chapter 11. "In order for a beleaguered debtor to prepare a proposed plan of reorganization, it may be necessary to protect the codebtor principals of the debtor from their creditors in order to allow them time to do the necessary work." In re A.J. Mackay Company, 50 B.R. 756 (D.Utah 1985) (dictum). Cf., 2 COLLIER ON BANKRUPTCY ¶ 362.05, at 362-37 (15th ed. 1985) (under Section 105 the court has ample power to enjoin action excepted from the automatic stay which might interfere with the rehabilitative process.)⁸

In In re Johns-Manville Corp., supra, 26 B.R. at 420, the best known of this line of cases, Judge Lifland extended the protection of the automatic stay to prohibit the continued litigation, including discovery, against all employees and executives of Manville. The propriety of this stay was upheld by the district court in In re Johns-Manville, supra, 40 B.R. at 219, and by the Fifth Circuit in In re Davis, 730 F.2d 176 (5th Cir.1984). The debtor's motion in this case appears to have been patterned after the one in Johns-Manville.

From the courts which have considered the question, no clear guidelines have emerged that may be applied in deciding whether to grant this extraordinary type of relief. See generally, "Case Study: Trio of Cases Illustrate Current Scope of Injunctive Relief Freezing Creditor Action Against Nondebtors," Broken Bench Review, Vol. 4, No. 3, pp. 17-22 (March, 1985). Clearly, something more than the mere fact that one codefendant has filed a Chapter 11 petition must be shown in order to warrant a stay of proceedings against a nondebtor codefendant. Royal Truck & Trailer, Inc. v. Armadora Maritima Salvadorena, S.A., supra, 10 B.R. at 491.⁹ If the litigation against the nondebtor merely has an indirect or insignificant effect on the reorganization, a stay is likewise unwarranted. See In re Magnus Harmonica Corp., sup...