Seventh Circuit Gives CEOC an Appellate Victory on Bankruptcy Court Equitable Powers

Worried business people in a meeting at board room

Caesar’s Entertainment Operating Company (along with numerous affiliates, collectively “CEOC”) filed the largest bankruptcy in Chicago’s bankruptcy court in recent memory. Large Chapter 11 filings in Chicago have been rare ever since the Kmart decision, when Judge Easterbrook ruled that Section 105 of the Bankruptcy Code, which provides that a court “may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title,” did not allow the broad critical vendor order that had been issued. Since 2000, bankruptcy filings for large firms have increasingly been concentrated in New York and Delaware.

When CEOC filed, its corporate parent, Caesar’s Entertainment Company (“CEC”) had been embroiled in several lawsuits in New York and Delaware, where the plaintiffs (who are also many of the creditors in the CEOC bankruptcy) alleged that CEC stripped valuable assets from CEOC and obtained releases of guarantees worth billions. In the bankruptcy, CEOC proposes going after CEC for many of the same transactions as fraudulent transfers.

There was a fight to even have the bankruptcy in Chicago instead of Delaware. Two days before CEOC filed here, several creditors filed an involuntary petition against CEOC in Delaware. CEOC moved to transfer the involuntary case to Chicago, and the bankruptcy judge in Delaware ordered the transfer, reasoning that even though both sides were forum shopping for favorable law, the debtor’s choice of venue should be paramount.

There has been speculation that CEOC chose Chicago because the Seventh Circuit allows broader involuntary releases of third parties than Delaware. In In re Airadigm, the Seventh Circuit held that a bankruptcy court may approve a plan of reorganization with a third party release “if the release is ‘appropriate’ and not inconsistent with any provision of the bankruptcy code.” CEOC envisioned a plan where CEC (the non-debtor third party) would be granted a release in exchange for a sum of money to pay CEOC’s creditors through bankruptcy. CEOC lenders would get paid (something) and CEC would have peace, all without a bankruptcy of its own.

But all the third-party releases in the world would not help CEC if its creditors won in state court first. So CEOC sued to enjoin the plaintiffs under Section 105 of the bankruptcy code. Not only had the Seventh Circuit instructed in Kmart to read 105 narrowly, there were two cases from the Seventh Circuit suggesting that Section 105 injunctions to stay related litigation should only be granted in narrow circumstances: when the litigation involves the same pool of money, and when it involves the same acts. Fisher v. Apostolou, In re Teknek. Judge Goldgar ruled that the guarantee litigation did not arise out of the same acts.

On December 23, 2015, the Seventh Circuit, in an opinion by Judge Posner, reversed Judge Goldgar’s refusal to enjoin ongoing litigation in New York and Delaware concerning the guarantees. Judge Posner held that Section 105 injunctions should be issued when they are “appropriate to carry out the provisions of the Bankruptcy Code”, and that “successful resolution of disputes arising in bankruptcy proceedings is one of the Code’s central objectives.” Then Judge Posner imagined a situation (much like the one CEOC attempted to demonstrate in the Section 105 trial held before Judge Goldgar) where litigation against a solvent parent would deprive a debtor of the opportunity to reorganize. The Seventh Circuit did not enter the injunction: rather, it remanded for Judge Goldgar to sort through the facts to determine whether the factual situation was as CEOC attempted to portray it.

Two important takeaways from the new CEOC decision. First, Kmart should probably be confined to its narrow holding: critical vendor orders paying some unsecured creditors for prepetition debts that aren’t supported by a finding that other unsecured creditors would benefit are beyond the scope of Section 105. Second, Section 105’s language should be read literally. Bankruptcy judges have the power to issue any orders that are “appropriate” to carry out the provisions of the Code, even to bring outside but related litigation to a successful resolution by enjoining litigation before other courts. Appropriate can be vague, and even when straightforward will be highly fact-specific.

One consequence may be larger Chapter 11s filed in the Northern District of Illinois. If you find yourself in need of skilled local counsel, give us a call.