In Re Excel Innovations, Inc.

Citations: 502 F.3d 1086; 2007 U.S. App. LEXIS 21459; 48 Bankr. Ct. Dec. (CRR) 212; 2007 WL 2555941Docket: 06-17288

Court: Court of Appeals for the Ninth Circuit; September 7, 2007; Federal Appellate Court

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Excel Innovations, Inc. sought a preliminary injunction to stay arbitration between Indivos Corporation and its former CEO, Ned Hoffman. The bankruptcy court granted this injunction, believing it could impact the debtor and its estate. The Bankruptcy Appellate Panel affirmed the decision, leading to an appeal. The Ninth Circuit determined that a bankruptcy court must weigh the debtor’s chances of successful reorganization against the hardships faced by the parties in such injunction requests. The court found that the bankruptcy court had misapplied the legal standard, prompting a reversal and remand for further proceedings.

Background details include that Hoffman, a major shareholder in both Indivos and Excel, had entered into several agreements with Indivos in 2000 to separate himself from its management. While Excel was not party to all agreements, it was involved in a Voting Trust and Standstill Agreement, which restricted Hoffman's influence over Indivos. Indivos initiated arbitration in June 2003 against Hoffman and Excel, alleging attempts to disrupt a merger with Solidus Networks and claiming multiple breaches of the Settlement Contracts. The arbitrator ruled in May 2004 that Hoffman breached the contract by taking actions against the merger.

The arbitrator determined that Excel was liable as Hoffman's alter ego for certain lawsuits filed under Hoffman's direction but denied summary judgment on other lawsuits. Additionally, the arbitrator denied summary judgment regarding merger-disrupting actions by two alleged surrogates of Hoffman and postponed decisions on patent rights until federal patent litigation was resolved. Indivos' unfair business practices claim was dismissed without prejudice. Following a setback in May 2004, where a judge ruled that the patents Excel accused Indivos of infringing were owned by Indivos, Hoffman and Excel filed for bankruptcy under Chapter 13 and Chapter 11, respectively, which automatically stayed the arbitration and patent litigation. At that stage, Indivos and Solidus had completed their affirmative case, and Hoffman and Excel had presented a significant part of their defense. Hoffman's bankruptcy petition was dismissed in September 2004, and he resigned from Excel in December 2004. In February 2005, Indivos resumed arbitration against Hoffman, arguing that the stay from Hoffman's bankruptcy had been lifted. The arbitrator ruled that while claims directly related to Excel were stayed, claims solely against Hoffman could proceed. No further evidentiary hearings were scheduled, and closing briefs were requested by July 29, 2005. In July 2005, Excel initiated adversary proceedings in bankruptcy court against multiple parties, claiming the arbitration violated the automatic stay. Excel sought a temporary restraining order (TRO) to halt the arbitration, which the bankruptcy court denied based on assurances that the arbitration would not impact Excel. Subsequently, Hoffman sought changes to the briefing schedule, leading to a request to reopen Excel's TRO motion. The bankruptcy court then issued a TRO, citing concerns about potential revelations of privileged information. In September 2005, Excel filed a motion for a preliminary injunction.

Hoffman, former CEO of Excel and now a consultant, provided an affidavit supporting a motion that aimed to prevent arbitration against him, citing three reasons for potential harm to Excel. Firstly, he indicated he would seek indemnification from Excel as he was acting in his official capacity during the relevant events, which could create new liabilities for Excel. Secondly, his defense would prioritize his personal interests over those of Excel. Thirdly, he would need to disclose privileged communications with the Debtor’s attorneys, as he acted based on their legal advice, and he planned to call Excel employees as witnesses.

The bankruptcy court granted an injunction to stay arbitration until Excel's reorganization plan was confirmed, stating that a 105(a) injunction is appropriate if arbitration could affect the bankruptcy estate's administration. The court found a "reasonable probability" of negative impacts on the estate and determined that Excel met the traditional criteria for a preliminary injunction, balancing the likelihood of success against potential hardship. Although the court did not assess the plaintiff's likelihood of success, it concluded that a stay would safeguard Excel without harming Indivos and Solidus.

Indivos and Solidus appealed, arguing that the bankruptcy court misapplied the legal standard for the injunction. The Bankruptcy Appellate Panel (BAP) affirmed the court's decision, noting the lack of a Ninth Circuit standard for a 105(a) motion against a nondebtor and citing Fourth Circuit precedents indicating such an injunction is suitable when debtor and nondebtor interests are intertwined. The BAP concluded that the bankruptcy court correctly exercised its 105(a) authority and also found that Excel had demonstrated a likelihood of success on the merits and the risk of irreparable harm if arbitration proceeded.

The BAP confirmed its jurisdiction over the appeal, affirming the bankruptcy court’s injunction as a final decision, akin to an extension of the automatic stay, to prevent disruption of Excel's reorganization process.

A decision regarding relief from the automatic stay under 11 U.S.C. § 362(a) is deemed a final order for appellate purposes, as established in Crocker Nat'l Bank v. Am. Mariner Indus. Inc. The current case is not treated differently, as the automatic stay functions as an injunction from the bankruptcy court, and the bankruptcy court's labeling of the injunction as 'preliminary' does not imply further proceedings are needed. If no additional hearings are anticipated beyond the reorganization outcome, the injunction qualifies as a final, appealable order.

The Bankruptcy Appellate Panel (BAP) decision is reviewed de novo, with the injunction being reversible only if the bankruptcy court abused its discretion by applying an incorrect legal standard or making clearly erroneous factual findings. Under 11 U.S.C. § 105(a), bankruptcy courts may issue orders necessary to uphold the Bankruptcy Code, including stays against actions that threaten the integrity of a bankrupt's estate.

The standard for granting a § 105(a) preliminary injunction against a non-debtor is an emerging issue. Appellants assert that the traditional preliminary injunction criteria apply, while Excel contends that it suffices for the movant to align the injunction with the Bankruptcy Code's objectives. Typically, the moving party must demonstrate a strong likelihood of success on the merits, potential irreparable harm, a favorable balance of hardships, and, in certain cases, advancement of the public interest. Alternatively, an injunction may be granted if there is probable success with potential irreparable harm or if serious questions arise, with a significant tilt in the balance of hardships favoring the plaintiff. The decision reiterates that these criteria are interrelated rather than distinct, reflecting varying degrees of required irreparable harm based on success likelihood.

In Rubin v. Pringle and related cases, the Ninth Circuit clarified that the standard for issuing preliminary injunctions in bankruptcy contexts differs from traditional standards. Specifically, when a bankruptcy court issues injunctions under 11 U.S.C. § 105, it does not need to demonstrate an inadequate legal remedy or irreparable harm. However, most circuit courts, including the Sixth, Fourth, and Fifth, have upheld the traditional preliminary injunction standard for stays against non-debtors, citing legislative history supporting this approach. The Eighth, Third, and Second Circuits also apply this standard for non-automatic stays. In contrast, the Seventh Circuit has ruled that irreparable harm need not be shown if defendants are violating applicable statutes. Ultimately, the Ninth Circuit determined that the traditional preliminary injunction standard applies to stays under § 105(a), aligning with Congressional intent, while emphasizing that the automatic stay provisions do not extend to non-debtors. The ruling aims to prevent the granting of stays without sufficient justification.

Crown Vantage addressed the application of the Barton doctrine, which restricts lawsuits against court-appointed receivers without court approval. The bankruptcy court initially granted an injunction against a state court action, but the district court vacated it due to the trustee's failure to demonstrate irreparable harm. Upon appeal, the court reversed this decision, asserting that an injunction under § 105 of the Bankruptcy Code does not require proof of irreparable harm in the context of a Barton violation, especially when the movant is virtually guaranteed success. 

The court clarified that there is no blanket prohibition on lawsuits against non-debtors. To secure equitable relief, the party must meet the standard for a preliminary injunction, which includes demonstrating a likelihood of success. The appellant argued that the debtor, Excel, must show a likelihood of success on its specific claims, while Excel contended that it only needed to demonstrate a likelihood of successful reorganization. The court held that a debtor must show a reasonable likelihood of successful reorganization to obtain a stay against actions involving non-debtors. 

The court noted that the only relevant future proceeding is the debtor's reorganization, as Excel's claim revolves around the assertion that arbitration would jeopardize its ability to reorganize. Hence, requiring a showing of a reasonable likelihood of successful reorganization is appropriate. It emphasized that the preliminary injunction standard encompasses an evaluation of the debtor’s likelihood of reorganization, the hardships to the parties, and any pertinent public interest factors.

Both the bankruptcy court and the Bankruptcy Appellate Panel (BAP) misapplied legal standards regarding preliminary injunctions. The bankruptcy court incorrectly stated that it could issue a preliminary injunction if another forum's action might impact the bankruptcy estate, conflating subject matter jurisdiction with the criteria for granting injunctions. The BAP erroneously applied the "unusual circumstances" doctrine from the Fourth Circuit’s Piccinin case as a separate basis for affirming a stay, despite it being an extension of traditional injunction standards. This doctrine requires a distinct showing of unusual circumstances linking the debtor's and non-debtor's interests, which was not adequately addressed.

The bankruptcy court and BAP's findings of warranting preliminary injunctive relief under the usual standard were flawed. Notably, the bankruptcy court failed to assess whether the debtor demonstrated a reasonable likelihood of success on the merits, a critical component of the injunction standard. While the BAP found some evidence of a potential successful reorganization, citing Hoffman's marketing efforts, this was insufficient given that the record indicated Excel had not generated income for the past two years. The BAP’s conclusion lacked evidentiary support, constituting an abuse of discretion.

Furthermore, the necessary analysis of the balance of hardships between the parties was inadequately considered, as the bankruptcy court must evaluate the potential harms to defendants against the plaintiff's threatened injuries.

The bankruptcy court and the Bankruptcy Appellate Panel (BAP) failed to adequately consider the potential harm to Indivos, which claimed it would be prejudiced by the inability to pursue arbitration against Hoffman at its discretion. The bankruptcy court concluded that a limited delay in arbitration would not cause significant harm but did not substantiate this claim. It neglected to assess the specific risks to Indivos's contractual rights, which constitutes reversible error. While the court identified possible harms to Excel, including the risk of inconsistent results and the disclosure of privileged communications, these were deemed insufficient to demonstrate irreparable harm. The court's concerns about agency arguments causing problems for Excel lacked clarity and relied on speculative injury, which cannot justify an injunction. Furthermore, any outcome from the arbitration would not impose new liabilities on Excel, as it is not a party to the arbitration. The BAP's concerns about inconsistent judgments were similarly unconvincing, as Hoffman's status as an agent would not alter his liability to Indivos if a breach occurred. Additionally, the notion of "unusual circumstances" that might warrant a stay in actions against a debtor's officers remains ambiguous in the Ninth Circuit.

The bankruptcy court did not find sufficient evidence to establish that there is an identity between the debtor and Hoffman that would allow a judgment against Hoffman to be considered a judgment against the debtor. The court failed to determine whether Hoffman had an indemnity agreement with Excel that would cover his potential liabilities in arbitration. Additionally, the court noted Hoffman's possible defense of indemnification but provided no insight into Excel's actual exposure. Unlike previous cases, there was no evidence of an insurance policy or assets that could address Hoffman's defense costs.

The court recognized that Excel might suffer harm if Hoffman reveals privileged communications with Excel's counsel in his defense, but Hoffman's mere threat to disclose such communications was deemed insufficient to demonstrate irreparable harm. The burden of proving attorney-client privilege rests with the party asserting it, and there was no evidence presented to support that the threatened communications were privileged. Furthermore, it was unclear how such disclosures would hinder Excel's operations under the Bankruptcy Code.

Excel claimed it would incur litigation expenses in participating in the arbitration to protect its privileged communications, but since the arbitration does not involve Excel directly and is not subject to the automatic stay, these expenses alone do not constitute irreparable harm. Excel needed to show that these costs would significantly interfere with its reorganization efforts or harm creditors, which it failed to do. The bankruptcy court did not adequately apply the standard for a preliminary injunction, overlooking Excel’s likelihood of success and the alleged harm to other parties involved. The court appeared to grant the injunction based on an incorrect assumption that any related proceeding should be enjoined, thereby lowering the standard of proof required to demonstrate irreparable harm.

Excel's inadequate demonstration of a successful reorganization increased its burden to prove irreparable harm, which is essential for establishing standing for preliminary injunctive relief. The legal precedent requires plaintiffs to show immediate threatened injury rather than simply alleging imminent harm. The bankruptcy court's error in applying an excessive burden of proof for irreparable harm constituted an abuse of discretion. Consequently, the court must balance the debtor's chance of successful reorganization against the hardships faced by the parties involved. As the bankruptcy court misapplied legal standards, the preliminary injunction was vacated and the case was remanded for further proceedings. Additionally, Hoffman's alleged unfair business practice involved attempting to disrupt a merger while simultaneously suing Indivos over patent ownership claims related to Excel. The automatic stay under 11 U.S.C. § 362(a)(1) applies to proceedings against the debtor that could have been initiated prior to the bankruptcy case. The document also notes that the question of privilege between Excel and Hoffman remains unresolved, impacting Excel's rights if Hoffman discloses privileged information.