April 27, 2011 Articles

Beware of the Bankruptcy Court's "Related To" Jurisdiction

Disputes that do not fall within the court's jurisdiction are put on hold until the "related" dispute is resolved

By David B. Goodman

To litigators who are not "regulars" in Bankruptcy Court, the expansive reach of that court's jurisdiction to disputes beyond the debtor’s estate may come as a surprise. The Bankruptcy Court has the power under its "related to" jurisdiction to stay litigation concerning property that is not property of the estate but that is likely to affect the amount of property available for distribution or allocation among the estate's creditors. The Bankruptcy Court's ability to stay proceedings can extend to litigation concerning rights and interests beyond those that may be brought in the bankruptcy proceedings. This circumstance may arise in connection with direct claims against the debtor's former directors and officers when those individuals are defended through a D&O insurance policy purchased by the debtor. A case in point might involve fraud claims brought in state court by a creditor against the former directors and officers of the debtor. It may also arise from competing claims by the estate and various creditors relating to professional services such as audit services provided to the debtor. For example, creditors might bring claims against an audit firm arising from the same conduct that gives rise to a claim by the debtor against the firm. In each instance, the litigation outside bankruptcy arises from injuries arguably unique and personal to the individual creditors that brought the actions but that may impact the assets available to satisfy claims brought by the trustee for the benefit of the creditors as a whole. The practical effect of such a stay is that disputes that do not fall within the court's jurisdiction are put on hold until the "related" dispute is resolved. This provides the trustee with an opportunity to get a jump start on parties pursuing the same assets.

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