The Automatic Stay does not Extend to Non-Debtor Entities

Isabella Benchetrit 

St. John's University School of Law 

American Bankruptcy Institute Law Review Staff

In In re Diocese of Rochester, the United States Bankruptcy Court for the Western District of New York held that the automatic stay, under section 362 of the Bankruptcy Code, does not extend to the non-debtor affiliated entities, including parishes, schools, and other Catholic institutions (“Catholic Corporations”).[1]

On September 19, 2019, the Diocese of Rochester (“Diocese”) filed a petition under Chapter 11 which stayed all litigation against the Diocese.^[2] This case concerns whether litigation brought by the victims of child sexual abuse (“Abuse Survivors”) pursuant to the Child Victims Act (“CVA”) is stayed against the non-debtor Catholic Corporations. The Diocese maintained that the Catholic Corporations are “separate legal entities,” and asserted that the assets of the non-debtor Catholic Corporations are beyond the reach of the Court.[3] The Diocese sought a judgment declaring that the automatic stay prevents the Abuse Survivors from proceeding with litigation in their state court actions against the non-debtor Catholic Corporations.[4] Or alternatively, the Diocese sought an injunction barring the Abuse Survivors from continuing with their state court actions against any of the Catholic Corporations for ninety days from the effective date of a confirmed Chapter 11 plan.^[5] Given the plain language meaning of sections 362(a)(1) and (a)(6), a stay in bankruptcy only applies to the debtor.[6] The Court refused to extend the automatic stay to the Catholic Corporations or to grant the Diocese’s injunction.[7]

The Diocese argued that any and all litigation against the Catholic Corporations would diminish the insurance coverage available to the Diocese and therefore needed to be stayed.[8] In rejecting the Diocese’s argument, the Court found that the Diocese failed to sustain its burden of proof as the Diocese did not show “that a specific CVA case would have a materially adverse impact on the per-occurrence limits of a specific policy of insurance.”[9] The Court declined to accept the Diocese’s argument that “any state court litigation by any Abuse Survivor against any Catholic Corporation” would adversely affect property of the Diocese’s Estate.[10] The Diocese asserted that “litigation in the CVA cases (even if only against the [Catholic Corporations]) [would] . . . erode collective insurance coverage shared by the Diocese and the [Catholic Corporations].”[11] The Court refused to accept the Diocese’s broad assertion that all CVA litigation would categorically implicate property of the Diocese’s estate.[12] The Court did not entertain the Diocese’s notion that the automatic stay should be extended to the Catholic Corporations because the Diocese did not show any specific erosion of insurance coverage.[13] Therefore, the Court concluded that section 362(a)(3) does not stay litigation by Abuse Survivors against non-debtor Catholic Corporations.[14]

Alternatively, the Diocese moved for an injunction under section 105 to “immediately enjoin the Abuse Survivors from moving forward with their state court actions against the Catholic Corporations.”[15] To obtain a preliminary injunction, a movant must demonstrate; (1) the likelihood of success on the merits, (2) the likelihood of irreparable harm to the movant absent the injunction issuing, (3) that the balance of hardships tips decidedly in favor of the movant, and (4) that the issuance of injunction is in the public interest.[16] Applying these four factors, the Court found that the Diocese failed to demonstrate that a preliminary injunction was warranted.[17] In bankruptcy, “likelihood of success on the merits” is interpreted by the courts as “likelihood of successful reorganization.”[18] In denying the Diocese’s request for an injunction, the Court reasoned that the likelihood of a successful reorganization is not a given, especially because the Diocese suggested that it may seek to confirm a Chapter 11 plan without the consent of the Abuse Survivors.^[19]

In the bankruptcy context, “irreparable harm” is considered to be the key element necessary to justify the grant of an injunction.[20] Preliminary injunctions have been issued “where the action to be enjoined is one that threatens the reorganization process.”[21] The Diocese argued that allowing the Abuse Survivors to pursue their actions against the Catholic Corporations would threaten the reorganization process by depleting insurance proceeds.^[22] The Court was not convinced that the Diocese would experience “irreparable harm” if the Court refused to grant the requested injunction because this Decision and Order specifically “prohibits all Abuse Survivors from attempting to enforce a CVA judgment granted by any court from executing against the proceeds of any insurance policy that names the Diocese as a co-insured.”[23] Further, the Court was not persuaded that as a result of this decision an irreparable economic consequence would ensue for the Diocese because the state court CVA cases have not progressed in litigation beyond the filing stage.[24]

The Court concluded that the balance of harms tips decidedly in favor of the Abuse Survivors rather than the Diocese because if the stay of litigation against the Catholic Corporations were to continue, an increasing number of Abuse Survivors would not have the opportunity to have juries hear their cases.[25] As the injunction sought by the Diocese is tied to the effective date of a confirmed Chapter 11 plan, a date which the Court found to be “nebulous,” the stay of litigation would continue without a clear end in sight.[26] Some of the Abuse Survivors have already lost their right to have their cases heard in a court of law, three of whom died while this Chapter 11 case was pending.[27] Finally, the Court unequivocally held that the public interest factor “strongly favors denial of the injunctive relief sought by the Diocese.”[28] The Court refused to place the value of the public services performed by the Diocese above the interests of the Abuse Survivors in seeking justice and the right to proceed with their CVA cases against the Catholic Corporations.[29] The Court opined that the appropriate remedy for the Catholic Corporations is to seek their own bankruptcy protection rather than for the Court to issue a sweeping injunction to continue to shield the non-debtor Catholic Corporations.[30]

In summation, the Court declined to extend the automatic stay to the non-debtor Catholic Corporations and refused to grant the Diocese’s request for an injunction.[31]