Phar-Mor, Inc. v. Coopers & Lybrand, the Official Unsecured Creditor's Committee of Phar-Mor, Inc., Ivan Bowen, Ii, Robert J. Carr, Vernon L. Carson, Merle T. Carson, Robert M. Chase, Stephen M. Ehrlichman, Robert J. Frisby, Ronald Goldberg, Cecile Guthman, Howard D. Hirsh Revocable Trust, Walter Jacobson, Diane Dybsky Jacobson, Robert A. Judelson, Edward L. Lembitz Profit Sharing Plan, Marc Levenstein, Angela Levenstein, Maurice Sporting Goods, Inc., Protective Insurance Company, Robert A. Riesman, Jr., Philip E. Rollhaus, Jr., Jeanette M. Shea Trust, Spiegel, Inc. Supplemental Employee Retirement Plan for the Benefit of John J. Shea, Helen Shire, Jack Shire, Bernard M. Susman Revocable Trust, Glen R. Traylor, Union League Boys & Girls Clubs, Richard E. Weiss, John B. Whitted, Jr., Stein Roe Investment Trust, Olympus Private Placement Fund, L.P., Vencap Hold[ings] Pte Ltd., Odyssey Partners, L.P., Kemper Total Return Fund, Kemper Growth Fund, Kemper Retirement Fund--Series I, Kemper Retirement Fund--Series I
Docket: 93-3368
Court: Court of Appeals for the Third Circuit; June 6, 1994; Federal Appellate Court
The case involves Phar-Mor, Inc. as the plaintiff against its auditors, Coopers & Lybrand, stemming from allegations that the firm failed to identify or was complicit in a substantial fraud that contributed to Phar-Mor's bankruptcy. The Official Unsecured Creditors' Committee of Phar-Mor, Inc. is appealing a decision concerning its right to intervene in related federal district court proceedings under Section 1109(b) of the Bankruptcy Code, which permits creditors' committees to raise issues in Chapter 11 cases. The appeal questions whether this provision grants an unconditional right for the committee to intervene in federal court matters associated with the bankruptcy case. The case was argued on November 2, 1993, and decided on April 11, 1994, with rehearing requests denied on June 6, 1994. Legal representation included various attorneys for the committee, Phar-Mor, and Coopers & Lybrand, with other parties and amici curiae involved in the proceedings. The court included Circuit Judges Becker and Stapleton, along with Judge Restani from the U.S. Court of International Trade.
The lawsuit initially filed by Phar-Mor against Coopers for fraud and malpractice in state court was removed to federal court, where the Unsecured Creditors' Committee of Phar-Mor sought to intervene based on Federal Rule of Civil Procedure 24. Both Phar-Mor and Coopers opposed this motion, arguing that Section 1109(b) of the Bankruptcy Code did not grant the Committee an unconditional right to intervene, as it only applied to cases directly under Chapter 11, not merely related cases. They distinguished the precedent set in *In re Marin Motor Oil, Inc.*, asserting that it applied solely to adversary proceedings initiated by a trustee under Chapter 11, while the current lawsuit was a common law civil action.
The district court sided with Phar-Mor and Coopers, denying the Committee's motion to intervene. However, upon appeal, the decision was reversed. The appellate court concluded that the Phar-Mor/Coopers lawsuit qualifies as an adversary proceeding and that Section 1109(b) does provide the creditors' committee with the right to intervene, even in cases related to a bankruptcy matter.
The background details reveal that Phar-Mor, having discovered fraudulent activities by executives, sued Coopers for approximately $1 billion in damages and subsequently filed for reorganization under Chapter 11. Coopers then removed the state action to federal court under a statute allowing removal of cases related to bankruptcy, prompting the Committee's intervention motion based on its interpretation of Section 1109(b).
The district court denied the Committee's motion to intervene in the Phar-Mor/Coopers lawsuit, ruling that Section 1109(b), as interpreted in the Marin case, does not confer an unconditional right for the Committee to intervene in federal district court proceedings that are merely related to a bankruptcy case. The Committee has appealed this decision, and the appellate court has jurisdiction, as an order denying intervention is appealable. Review of the district court's ruling on the intervention motion under Rule 24(a)(1) is plenary, given that it involves the interpretation of a statute.
Federal Rule of Civil Procedure 24(a)(1) allows intervention when a statute confers an unconditional right. The interpretation of Section 1109(b) hinges on the Marin case, where the court determined that creditors' committees have an unconditional right to intervene in adversary proceedings initiated by a trustee in Chapter 11 cases. The Marin decision arose from a situation where a trustee opposed a creditors' committee's intervention, claiming that Section 1109(b) only applied to 'cases,' not adversary proceedings. The court countered that 'case' encompasses any adversary proceeding initiated by a trustee, supporting this interpretation with legislative history and the expectation that parties in interest should be heard.
While some courts have accepted Marin's interpretation, others have rejected it, arguing that Section 1109(b) does not grant creditors' committees an unconditional right to intervene in adversary proceedings, even those under Chapter 11. Notable cases supporting and opposing this interpretation include In re Neuman and Fuel Oil Supply & Terminaling v. Gulf Oil Corp., among others.
Three primary reasons have been advanced by courts rejecting Marin's interpretation of the scope of Section 1109(b). First, Congress has consistently distinguished between bankruptcy 'cases' and related 'adversary proceedings' within the bankruptcy statutory framework. Second, courts have interpreted Rule 24(a)(1) narrowly, hesitating to grant private parties an unconditional right to intervene. Third, Bankruptcy Rule 7024 and its advisory committee note suggest Congress was aware of this distinction and did not intend to extend the right to intervene to adversary proceedings. Critics of Marin argue that these legislative and judicial interpretations indicate that Congress intended interventions under Section 1109(b) to be governed by Rule 24(a)(2) instead of Rule 24(a)(1).
The treatise "Collier on Bankruptcy" also critiques Marin, suggesting that the Marin panel misinterpreted the legislative history of Section 1109(b) and that established case law supporting the notion that Section 1109(b) does not provide an automatic right to intervene under Rule 24(a)(1) is more persuasive. Collier emphasizes that if Congress intended for Section 1109(b) to be broadly interpreted, it would have used terminology other than 'case,' highlighting the established distinction between a 'case' and a 'proceeding' in the Bankruptcy Rules since 1973.
Despite these criticisms, Marin remains binding precedent. Phar-Mor and Coopers seek to limit Marin's application, arguing that the right to intervene recognized in Marin pertains only to adversary proceedings directly 'under' Chapter 11, not to common law malpractice actions merely 'related to' a Chapter 11 case. They assert that Marin only indicated that 'case' encompasses some adversary proceedings, but does not address actions 'related to' a case.
The court must determine if Phar-Mor and Coopers' limitations on Marin are consistent with the principles underlying Section 1109(b) as interpreted by Marin, specifically addressing the distinctions between adversary/non-adversary proceedings and 'related to'/'under' classifications. These considerations are crucial given the fundamental changes in bankruptcy jurisdiction since Marin's decision.
The excerpt outlines the evolution of bankruptcy jurisdiction following the Bankruptcy Reform Act of 1978. Initially, federal district courts served as bankruptcy courts, often delegating authority to referees who managed disputes and administration. The 1978 Act abolished this referee system, creating Article I bankruptcy courts with jurisdiction over cases "arising under" or "related to" title 11, allowing them to address both federal and state law claims.
However, the Supreme Court's 1982 decision in Marathon deemed the jurisdictional grant unconstitutional, stating that Congress could not confer jurisdiction over state law rights independent of bankruptcy proceedings. To mitigate potential disruption to the bankruptcy system, the Court delayed the ruling's effect, providing Congress time to amend the structure. Congress's inaction led to the implementation of an "Emergency Rule" allowing federal district judges to exercise full bankruptcy jurisdiction while permitting referrals to bankruptcy judges, who could only make final decisions with consent from the parties for matters related to bankruptcy cases.
In 1984, the Bankruptcy Amendments and Federal Judgeship Act codified this framework, establishing that district courts would exercise initial jurisdiction and could refer cases to bankruptcy courts, typically via local rules or general orders.
To address Marathon's concerns, BAFJA established a distinction between 'core' and 'non-core' proceedings within the bankruptcy jurisdiction. Core proceedings arise under or in title 11 and involve substantive rights provided by bankruptcy law or are inherently linked to bankruptcy cases. Non-core proceedings are related to bankruptcy but do not invoke substantive rights from federal bankruptcy law and could exist outside of bankruptcy contexts. While both core and non-core proceedings can be referred to bankruptcy judges, only core proceedings allow for final decisions by the bankruptcy court.
The Phar-Mor and Coopers lawsuit was challenged as not being an adversary proceeding since it was a state law action removed to federal court due to its relation to a bankruptcy case. However, it was determined that this lawsuit qualifies as an adversary proceeding under Bankruptcy Rule 7001(10), which covers claims removed under 28 U.S.C. Sec. 1452. This applies even though the case is not classified as a core proceeding and is not in bankruptcy court, as the Bankruptcy Rules govern these proceedings, overriding the Federal Rules of Civil Procedure due to the specific exceptions in Rule 81.
Historically, the Bankruptcy Act of 1898 defined 'proceedings' narrowly, but the 1978 amendments expanded bankruptcy court jurisdiction, eliminating distinctions between summary and plenary matters. Therefore, had the prior jurisdictional framework remained, it would have been more convincing that Bankruptcy Rules applied to all related proceedings.
The distinction between substantive bankruptcy law and matters 'related to' bankruptcy cases has been revived, reflecting a pre-1978 Act framework. This raises the argument that the Federal Rules of Civil Procedure should apply to non-core, 'related to' proceedings, similar to plenary matters prior to 1978. However, courts have largely rejected this argument, emphasizing that it contradicts the policies of the Bankruptcy Amendments and Federal Judgeship Act (BAFJA), which was not intended to revert to the jurisdictional system of the 1898 Act. The potential dual procedural system, requiring plaintiffs to classify actions as 'core' or 'non-core' in every adversary proceeding, would hinder the efficient handling of bankruptcy cases, a core principle of the BAFJA.
Instead, both bankruptcy judges and district court judges should apply the same procedural rules across all proceedings linked to a bankruptcy case, including those 'arising under,' 'arising in,' and 'related to' a bankruptcy case. Support for this position is found in the analysis of the Bankruptcy Rules. Notably, amendments to Bankruptcy Rule 1001 removed language limiting the rules to bankruptcy court cases, indicating their applicability to federal district courts. Similar amendments to Rule 7001 eliminated restrictions to bankruptcy court adversary proceedings, allowing the Bankruptcy Rules to apply to cases before district courts.
Furthermore, the language of Bankruptcy Rule 7001 encompasses non-core, 'related to' proceedings, as it includes provisions for actions such as property recovery and civil actions removed under Section 1452. Courts have consistently affirmed that certain Bankruptcy Rules, like Rule 7004 on nationwide service of process, apply to both core and non-core proceedings in district courts. Additionally, a bankruptcy court in the circuit has ruled that Bankruptcy Rule 7013 concerning counterclaims governs non-core proceedings withdrawn to district court.
The Bankruptcy Rules apply to non-core, 'related to' proceedings in district courts, such as the Phar-Mor/Coopers lawsuit, making reliance on Part VII of these rules appropriate for its characterization. Bankruptcy Rule 7001(10) categorizes this lawsuit, removed under Section 1452, as an adversary proceeding, fulfilling one requirement outlined in Marin. There is a debate regarding whether Section 1109(b), as interpreted by Marin, extends to adversary proceedings 'related to' a Chapter 11 case. Phar-Mor and Coopers assert that Marin's interpretation only pertains to core proceedings under Chapter 11. However, the court disagrees, finding no limitations in Marin that restrict its application to adversary proceedings 'under' Chapter 11. At the time Marin was decided, the jurisdictional distinctions between 'under' and 'related to' Chapter 11 proceedings were not yet significant. The court notes that Marin itself may have allowed intervention in an adversary proceeding that was merely 'related to' a Chapter 11 case, as it involved actions typical of non-core proceedings. Thus, the interpretation of Section 1109(b) appears to be broad enough to encompass adversary proceedings 'related to' a Chapter 11 case.
Section 1109(b), as interpreted by the Marin decision, extends to 'related to' proceedings, emphasizing its role as a counterbalance to a debtor-in-possession's power during reorganization. Typically, a corporate debtor retains control through its management, while the creditors' committee is tasked with oversight due to a reduced court role following the 1978 Act. The section serves as a crucial monitoring mechanism for creditors, enabling them to intervene and reduce the need for extensive judicial oversight, thereby facilitating efficient reorganization and protecting creditor interests. The argument against this intervention based on jurisdictional distinctions from the Marathon decision is viewed as misguided, as it could unfairly limit the creditors' committee's rights in favor of the debtor's discretion. Consequently, the court holds that Section 1109(b) permits creditors' committees to intervene in non-core, 'related to' proceedings in federal district courts, aligning with similar interpretations in other cases that recognize the committee's statutory rights in adversary proceedings connected to bankruptcy cases.
A creditors' committee has an unconditional right to intervene in non-core, related proceedings before a federal district court, as affirmed by the interpretation of Section 1109(b) in the Marin case. The court will reverse the district court's order denying the committee's right to intervene in the Phar-Mor/Coopers lawsuit and remand it for an order allowing intervention. The committee also argued for intervention based on Federal Rule of Civil Procedure 24(a)(2) and Rule 24(b), but the court's decision on Rule 24(a)(1) rendered these arguments unnecessary. Additionally, the document references the ongoing Phar-Mor bankruptcy case and related litigation, highlighting that multiple lawsuits against Coopers are pending in various federal courts. Intervention in bankruptcy cases is governed by specific rules for adversary proceedings, noting that such motions must be sought separately.
Phar-Mor and Coopers have the option to challenge the previous decision by filing for rehearing or certiorari, having maintained that the Marin decision was incorrect. The court established a rule aligned with the model Emergency Rule, which is applicable in the Western District of Pennsylvania as per the General Order of Reference from October 16, 1984, directing all cases and proceedings under Title 11 to bankruptcy judges for resolution. Under 28 U.S.C. § 1452, civil actions related to a bankruptcy case can be removed, and it is largely accepted that such removal was justified as the Phar-Mor/Coopers lawsuit significantly affects Phar-Mor's asset pool available for creditor distribution. Section 1334 grants jurisdiction to all district courts, including the Western District of Pennsylvania.
Once the district court determined that removal was appropriate under § 1452, the case should have been automatically referred to bankruptcy court as per the General Order, which specifies that cases related to Title 11 need not be pending in the same district. The lawsuit should have been filed as an adversary proceeding in the Pittsburgh bankruptcy court. The district court could later withdraw the reference for valid reasons, especially given several pending similar claims against Coopers. Transferring the case to Ohio was deemed unlikely, as the convenience favored retaining it in Pittsburgh. However, the district court erroneously kept the case on its docket, leading to the conclusion that the Phar-Mor/Coopers lawsuit is improperly before the district court. Nonetheless, when a district court retains a case that should have been referred, it is treated as if the reference had been properly withdrawn.
The local rule for automatic reference does not hinder the district court's authority to maintain jurisdiction, even if it disregards withdrawal of reference procedures. By retaining jurisdiction, the district court has effectively withdrawn the matter from the bankruptcy judge to whom it would have been automatically referred. This aligns with the precedent set in Cooper-Jarrett, which interpreted that failure to follow referral procedures constitutes a sua sponte withdrawal of reference. The district court's handling of the Phar-Mor/Coopers lawsuit is treated as if it had been originally referred to bankruptcy court and subsequently withdrawn.
Bankruptcy Rule 81 has not been substantively amended since 1971, despite changes in bankruptcy jurisdiction, with only technical amendments in 1987 that did not intend substantive change. An argument presented suggests that the Supreme Court's choice not to revise "proceedings in bankruptcy" in Rule 81(a)(1) indicates a desire to limit the application of the Federal Rules of Civil Procedure to all proceedings, whether core or non-core, especially after significant changes from the Bankruptcy Amendments and Federal Judgeship Act (BAFJA).
Phar-Mor and Coopers contend that the Bankruptcy Rules do not apply to "related to" cases under Title 11, citing that Rule 1001 governs procedures in cases under Title 11. However, the language does not exclusively pertain to cases "arising under" or "arising in," and the implication is that it does not exclude "related to" cases. Furthermore, there is no support for Phar-Mor's argument that using Bankruptcy Rules to determine if the lawsuit qualifies as an adversary proceeding under Section 1109(b) expands substantive rights, as this assumes that Section 1109(b) excludes adversary proceedings like the Phar-Mor/Coopers case.
Phar-Mor and Coopers also reference the Marin panel decision, arguing it limits the scope to adversary proceedings "arising under" Chapter 11. However, the Marin court did not differentiate between adversary proceedings "under" and "related to" Chapter 11; rather, the emphasis was on distinguishing reorganizations from liquidations, indicating a broader scope for creditor rights in reorganizations.
The Marin interpretation of "this chapter" in Sec. 1109(b) encompasses lawsuits removed to non-bankruptcy courts that are related to bankruptcy cases, such as the Phar-Mor/Coopers litigation. The proceeding to impose a constructive trust on the Marins' house likely constitutes a core proceeding under 28 U.S.C. Sec. 157(b)(2)(H), as it involves determining, avoiding, or recovering fraudulent conveyances. Although the adversary proceeding could be interpreted as a substantive consolidation, Marin does not classify it as such, and substantive consolidations are generally contested matters rather than adversary proceedings.
The Second Circuit has indicated that an alter ego action by a bankruptcy trustee against third parties is a core proceeding, as it can bring property into the debtor's estate. However, this broad interpretation raises concerns since a debtor's state law breach of contract action that brings property into the estate may be non-core and beyond the bankruptcy court's jurisdiction.
Piercing the corporate veil or alter ego actions are permitted in some states, including New Jersey, to prevent unjust outcomes, not solely based on creditor protection. This principle allows a debtor corporation to pursue such claims, aligning with the theory of preventing inequity.
Lastly, the case United States v. Nicolet, Inc. is deemed inapplicable to Phar-Mor and Coopers, as it does not provide relevant support for their position.
Nicolet I involved a lawsuit against Nicolet under CERCLA, leading Nicolet to file for bankruptcy. In subsequent case Nicolet II, the creditors' committee sought to intervene in Nicolet I, asserting an unconditional right to do so under Section 1109(b), but their motion was denied. The court opined that the right to intervene under Section 1109(b) hinges not on the case's relationship to Chapter 11, but on the existence of an overriding federal interest that supersedes the creditors' interests. In Nicolet II, such an overriding interest was identified due to the prioritization of environmental law enforcement over the debtor's rights and creditors' orderly estate administration. The court noted that, unlike in Nicolet II, there was no competing federal interest limiting the creditors' right to be heard in the current case. This reasoning aligns with interpretations found in leading legal treatises, which support the view that Section 1109(b) grants an unconditional right to intervention in adversary proceedings related to the bankruptcy case.
