Expanding the Unconditional Right to Intervene
October 2002
In a case of first impression before the Second Circuit Court of Appeals that may have a profound impact upon the conduct and resolution of adversary proceedings filed in a bankruptcy case, the Second Circuit ruled in Term Loan Holder Committee v. Ozer Group, L.L.C. (In re The Caldor Corporation) that any party in interest in a chapter 11 case has an unconditional right to intervene in any adversary proceeding commenced during the course of the case. In expanding the potential universe of litigants beyond that traditionally permitted in bankruptcy cases, the Court of Appeals rejected the restrictive approach applied by many courts, who permit parties-in-interest to appear and be heard on any matter arising in the main bankruptcy case, but limit participation in adversary proceedings to entities having either an independent statutory right to intervene or a direct financial stake in the outcome of the litigation.
Right to Be Heard in Bankruptcy
Unlike most ordinary litigation commenced in other federal courts, a bankruptcy case generally impacts the substantive rights of a large group of creditors, shareholders and other parties with a stake in the outcome of the case. As a consequence, bankruptcy courts, which are technically "units" of the federal district courts, permit anyone whose rights or remedies are affected by the case to appear before them and petition for the forms of relief contained in the Bankruptcy Code, such as relief from the automatic stay or "adequate protection" to the extent the debtor is using or leasing a creditor's collateral during the case. Specific provisions of the Bankruptcy Code confer what may be loosely referred to as "standing" upon the entity involved to seek certain kinds of relief under certain circumstances.
Still, with one exception (discussed below), the Bankruptcy Code does not expressly delineate the entities that have the right to participate generally in a bankruptcy case. Procedural rules enacted to implement the Code and various provisions of the statute suggest that participation is limited to debtors, trustees, creditors, shareholders, official committees and other entities whose rights are affected by the outcome of the case. The bankruptcy court (pursuant to Bankruptcy Rule 2018) may permit any entity who presumably does not fall into one of these categories "to intervene generally or with respect to any specified matter" in a "case" under the Bankruptcy Code, but the Code itself offers little guidance on this issue.
This stands in marked contrast to procedural rules that govern other federal litigation and the ability of parties other than the initial litigants to participate, or "intervene" in a lawsuit. These rules provide for intervention under two circumstances: as of right and with the permission of the court. "Intervention of right" under Federal Rule 24 is appropriate when a federal statute "confers an unconditional right to intervene" or when the potential intervenor "claims an interest relating to the property or transaction which is the subject of the action and the applicant is so situated that the disposition of the action may as a practical matter impede the applicant's ability to protect that interest, unless the applicant's interest is adequately represented by existing parties." By contrast, if the applicant's statutory right to intervene is only conditional, or if the applicant has a claim or defense based upon a question of law or fact that will be determined in the litigation, a federal court has the discretion to allow or disallow intervention.
The exception to the Bankruptcy Code's silence regarding who may participate in a bankruptcy case is contained in Bankruptcy Code section 1109(b). That section provides that "[a] party in interest, including the debtor, the trustee, a creditors' committee, an equity security holders' committee, a creditor, an equity security holder, or any indenture trustee, may raise and may appear and be heard on any issue in a case under this chapter." Section 1109(b) applies only to cases under chapter 11. Its reference to "a case under" chapter 11 has led to a considerable amount of confusion regarding whether the statute confers upon parties in interest the right to appear and participate in adversary proceedings, as opposed to the main bankruptcy case.
Case v. Proceeding
"Case" and "proceeding" have distinct meanings in bankruptcy. It is generally recognized that where the Bankruptcy Code and Rules refer to a "case," it means the main bankruptcy case that was commenced when the bankruptcy court entered an order for relief. By contrast, a "proceeding" means an "adversary proceeding" filed in the main case sometime afterward. An adversary proceeding is discrete but related litigation commenced during a bankruptcy case for the purpose of, among other things, determining the validity, priority or extent of a lien, subordinating a claim, recovering assets that were preferentially or fraudulently transferred, obtaining injunctive relief beyond the scope of the automatic stay or objecting to the discharge of a debt. Other types of disputed issues that arise in a bankruptcy case that do not qualify as adversary proceedings are referred to as "contested matters." Different procedural rules apply to adversary proceedings and contested matters.
Several provisions of the Bankruptcy Code, other related statues and procedural rules distinguish between a "case" and a "proceeding." For example, separate statutes and/or rules delineate the ability to conduct jury trials in "cases and proceedings," the right of the U.S. Trustee "to appear and be heard on any issue in any case or proceeding," the appropriate venue for bankruptcy cases and adversary proceedings and the circumstances under which a court can abstain from hearing either an entire bankruptcy case or a specific adversary proceeding filed in the case. Advisory committee comments to several procedural rules make the same distinction. For example, the comment to Bankruptcy Rule 7024, which makes the ordinary federal intervention rules (Federal Rule 24) applicable to adversary proceedings in bankruptcy, states that "[i]intervention in a case under the Code is governed by [Bankruptcy] Rule 2018 and intervention in an adversary proceeding is governed by this rule." It further notes that "[i]ntervention in a case and an adversary proceeding must be sought separately."
All of this has led many courts to conclude that Bankruptcy Code section 1109(b)'s reference to "any issue in a case" means that the right of a party in interest to participate is limited to the main chapter 11 case. According to this view, intervention in an adversary proceeding must be sought in accordance with Federal Rule 24, and section 1109(b) alone does not represent a federal statute that "confers an unconditional right to intervene" upon any party in interest in a chapter 11 case. Among the courts subscribing to this approach is the Fifth Circuit, which ruled in Fuel Oil Supply & Terminaling v. Gulf Oil Corp. that Congress drew distinctions between cases and proceedings in various statutes and procedural rules and did not intend to cerate an unconditional right to intervene in Bankruptcy Code section 1109(b).
Prior to the Second Circuit's ruling in Caldor, the only other circuit court of appeals to address the issue directly was the Third Circuit in Official Unsecured Creditors' Committee v. Michaels (In re Marin Motor Oil). In that case, the Court of Appeals examined the language section 1109(b) and its predecessor under the former Bankruptcy Act and concluded that section of 1109(b) should be interpreted broadly to afford a creditors' committee an absolute right to intervene in an adversary proceeding instituted in connection with a chapter 11 case. The First, Fourth and Tenth Circuits have indicated in dicta that they favor the Fifth Circuit's view. The Second Circuit opted for the more expansive approach in Caldor.
Background
The Caldor Corporation was once one of the largest discount retailers in the northeast, operating 145 stores in ten eastern seaboard states. Caldor filed for chapter 11 protection in 1995, beleaguered by increasing competition and rising costs. In connection with its efforts to reorganize, Caldor entered into a post-petition financing arrangement involving two of its pre-bankruptcy lenders: the holders of a term loan under a 1993 credit agreement (the "Term Loan Holders") and the holders of a real estate loan under a 1995 credit agreement. Both lenders looked toward the proceeds from the sale of Caldor's inventory and leases to satisfy their secured claims.
Caldor ultimately decided to liquidate and solicited bids for the right to purchase its remaining inventory of merchandise. With bankruptcy court approval, it entered into a purchase agreement with a group of liquidators, who conducted going out of business sales at Caldor's remaining stores and remitted the net sales proceeds to Caldor. After Caldor allegedly refused to honor certain purchase price adjustment provisions in the purchase agreement, the liquidators commenced an adversary proceeding against Caldor alleging breach of contract and seeking over $26 million in damages.
A committee representing the Term Loan Holders (the "Committee") sought to intervene in the adversary proceeding under Bankruptcy Code section 1109(b) and Federal Rule 24, arguing that the former gave them an unconditional statutory right to intervene. The Committee also claimed that because its constituents held the largest single administrative claim in the case and Caldor was administratively insolvent, the outcome of the litigation would have a significant impact on the amount that would be available to pay creditors. The bankruptcy court denied the Committee's motion. Acknowledging that there is a split in authority over whether section 1109(b) also applies to adversary proceedings, the court adopted the Fifth Circuit's approach in Fuel Oil as the better view. It also found that the Committee's interests in maximizing the value of the estate were adequately represented by Caldor in the litigation. The district court affirmed on appeal, observing that the Fifth Circuit's view "provided slightly more persuasive reasoning" than the broad approach espoused by the Third Circuit in Marin Motor Oil.
Case of First Impression
The Committee fared better on further appeal to the Second Circuit, which addressed the issue as a matter of first impression. Applying traditional principles of statutory construction, the Court of Appeals began its analysis by examining the plain language of section 1109(b) to determine whether it could be interpreted to establish the unconditional right of a party in interest in a chapter 11 case to intervene in an adversary proceeding. The Court acknowledged that the words "case" and "proceeding" have accepted meanings in the bankruptcy context, but found that this distinction did not dispose of the issue in light of the language of the statute. Specifically, the Court of Appeals emphasized, section 1109(b) provides that any party in interest has the right to appear and be heard not in a case, but "on any issue in a case."
Observing that an "issue" is a "point in dispute between two or more parties," the Second Circuit concluded that the "'issues' referred to in § 1109(b) occur in proceedings, which themselves occur in and constitute part of the 'case.'" It then reasoned that while the bankruptcy rules distinguish between different types of litigated matters that arise during the pendency of a bankruptcy case and divide them into "contested matters" and "adversary proceedings," the plain text of section 1109(b) "does not distinguish between issues that occur in these different types of proceedings within a Chapter 11 case." The Second Circuit accordingly held that the phrase "any issue in a case" plainly grants a right to raise, appear and be heard on an issue regardless of whether it arises in a contested matter or an adversary proceeding.
Based upon its conclusion that section 1109(b) is not in any way ambiguous, the Court of Appeals rejected the liquidators' argument that its interpretation of the statute was at odds with several procedural rules, advisory committee notes, legislative history and policy concerns. According to the Second Circuit, it need not consider these extrinsic sources because the statute is clear on its face. Moreover, it observed, even if extrinsic sources suggested a contrary interpretation, the law is clear that the statute prevails if it conflicts with a procedural rule.
The Court of Appeals found that its interpretation of section 1109(b) is not inconsistent with other statutes and procedural rules. For instance, addressing the liquidators' contention that reading section 1109(b) to permit intervention in an adversary proceeding by a party in interest would render Bankruptcy Rule 7024 superfluous, the Court remarked that 7024 was directed toward potential intervenors who are not parties in interest, just as Bankruptcy Rule 2018 empowers the bankruptcy court to permit non-interested parties to participate generally in a bankruptcy case. It found the advisory committee comment to Rule 2018 drawing a distinction between intervention in a case and proceeding to be "at best ambiguous," and in any event, not a "sufficient basis for determining that § 1109 is exclusively limited to proceedings for which Rule 2018 is applicable." It similarly found unpersuasive the liquidators' contention that Congress clearly distinguished between cases and proceedings in various statutory amendments enacted after the Bankruptcy Code was enacted in 1978, evidencing a "statutory scheme" to establish different rules governing participation in each. According to the Court of Appeals, "[t]hese distinctions . . . do not demonstrate that Congress, in the different context of deciding parties' rights within the substantive bankruptcy law, intended the term "case" to exclude adversray proceedings.
Finally, the Second Circuit was unmoved by the liquidators' policy-based argument predicated upon the potential for chaos in the bankruptcy courts created by opening the floodgates to an unlimited number of potential intervenors in adversary proceedings. Noting that the Third Circuit had considered such policy concerns "unrealistic" in Marin Motor Oil, the Court of Appeals observed that "[w]e need not choose among the competing policy rationales for and against an unconditional right, because we do not sit to assess the relative merits of different approaches to various bankruptcy problems." According to the Court, it is sufficient that the natural reading of Bankruptcy Code section 1109(b) produces the result that it reached.
Analysis
Caldor may have a significant impact on the ability of bankruptcy court's in the Second Circuit to adjudicate expeditiously the adversary proceedings filed in a chapter 11 case. If any creditor, shareholder or committee in a chapter 11 case has an unconditional right to participate in an adversary proceeding, courts may have to deal with an expanded universe of litigants whose only real stake in the outcome of litigation lies in its pecuniary ramifications for the bankruptcy estate. Given that championing the interests of the estate is among the fiduciary obligations of a chapter 11 debtor-in-possession or bankruptcy trustee, it would appear to be redundant and unnecessary to afford parties in interest an unconditional right to intervene.
Then again, the "floodgates" concern created by the Second Circuit's expansive interpretation of Bankruptcy Code section 1109(b) may be overblown. Other than an official committee, which is permitted to retain counsel at the estate's expense, few creditors or shareholders have the financial wherewithal or inclination to actively participate in litigation that only indirectly (if at all) affects their claims or interests. In fact, even after living with the rule of law stated in Marin Motor Oil for over a decade, the Third Circuit saw no reason to retreat from its position on policy grounds when it reaffirmed its broad interpretation of the statute in Phar-Mor, Inc. v. Coopers & Lybrand. Only time can tell whether Caldor will work any significant changes in existing practice before the bankruptcy courts in the Second Circuit.
Caldor does leave some important questions unanswered. Why, for example, should there be a distinction between the ability of a party in interest to intervene in an adversary proceeding in a chapter 11 case, and the same right in a case under any other chapter? As noted, Bankruptcy Code section 1109(b) applies only to chapter 11 cases. The stake of a party in interest in any bankruptcy case -- ensuring that the value of the estate is maximized -- is arguably as significant in a chapter 11 case as in a case filed under any other chapter. Without any guidance on this question, practitioners are left to wonder whether the mandatory and permissive intervention requirements in Federal Rule 24 apply to intervention in all cases other than chapter 11, while they do not apply in a chapter 11 cases except insofar as the potential intervenor is not a party in interest.
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Term Loan Holder Committee v. Ozer Group, L.L.C. (In re The Caldor Corporation), 2002 WL 31008730 (2d Cir. Sept. 9, 2002).
Fuel Oil Supply & Terminaling v. Gulf Oil Corp, 762 F.2d 1283 (5th Cir. 1985).
Official Unsecured Creditors' Committee v. Michaels (In re Marin Motor Oil), 689 F.2d 445 (3rd Cir. 1982).
Richman v. First Woman's Bank (In re Richman), 104 F.3d 654 (4th Cir. 1997).
Vermejo Park Corp. v. Kaiser Cola Corp. (In re Kaiser Steel Corp.), 998 F.2d 783 (10th Cir. 1993).
Kowal v. Malkemus (In re Thompson), 965 F.2d 1136 (1st Cir. 1992).
Phar-Mor, Inc. v. Coopers & Lybrand, 22 F.3d 1228 (3d Cir. 1994).
Text Box Excerpt:
Given that championing the interests of the estate is among the fiduciary obligations of a chapter 11 debtor-in-possession or bankruptcy trustee, it would appear to be redundant and unnecessary to afford parties in interest an unconditional right to intervene in adversary proceedings.