Are Bankruptcy Courts Creating a Co-Debtor Stay in Chapter 11 Reorganization Cases?

When collecting against an entity that files a Chapter 11 bankruptcy, I usually file an immediate suit against any guarantors of the debt. In Chapter 11, there is no statutory “co-debtor” stay, so there’s nothing stopping me from applying pressure to the other liable parties, who are usually the principals/owners of the company. The goal is not only to collect the debt from those parties, but also pressure the bankrupt entity to improve my client’s payment position.

Steve Jakubowski of the Bankruptcy Litigation Blog tweeted a recent decision that may scale back a creditor’s use of this tactic.

In the opinion, the debtors filed an adversary proceeding seeking an injunction of a collection action against guarantors, arguing that the collection action would adversely impact the ability of the debtor to reorganize.

The Bankruptcy Court agreed, finding that it had jurisdiction over the matter involving non-debtor entities under 11 U.S.C. 1334(b), since the action was “related to” to the underlying Bankruptcy. The Court found that the guarantors were “vital to the success of the reorganization process and that that the [collection action] would place a significant burden on Guarantors to the extent that [they] would not be able to adequately assist in the reorganization process.” Ultimately, the Court found that the guarantors were so critical to the reorganization process that the collection action against them would significantly impair the bankruptcy process and, thus, using 11 U.S.C. 105(a), the Court was willing to issue the injunction.

The Bankruptcy Court made clear that special factual circumstances existed, such as the guarantors’ past involvement and commitment to remain involved. Further, the Court noted that the guaranty liability isn’t extinguished and is, instead, only stayed during the pendency of the bankruptcy.

But, even with those safe-guards, it’s easy to imagine that this decision–if adopted by other courts–could create a common law co-debtor stay in Chapter 11s. Here’s a link to the full opinion:

Harris N.A. v. Gander Partners, LLC, No. 10-C-5495, 2011 WL 249484 (N.D. Ill. Jan. 26, 2011)

One thought on “Are Bankruptcy Courts Creating a Co-Debtor Stay in Chapter 11 Reorganization Cases?

  1. One debtor’s attorney will file an individual chapter 11, but then state that the individual debtor is doing business as XYZ, Inc. When questioned by the US Trustee’s office, they say that the corporation is not operating (never mind that it’s an active corporate with the secretary of state, no dissolution documents have been filed and the assets are recorded in the corporation’s name). The individual debtor basically says they aren’t using the corporation. They then take the position that the stay protects XYZ, Inc. even though it has not filed a petition and there is no co-debtor stay in a chapter 11. Creditors of XYZ, Inc. are left to file for relief from the stay or take their chances on possible sanctions….

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