When companies file for bankruptcy, they receive the immediate protection of an “automatic stay,” which halts all creditors’ collection activity and lawsuits seeking to recover funds from the debtor. This automatic stay provides debtors with a much needed “breathing spell” to get themselves organized and on the way, if possible, to reorganization. However, creditors are not completely without recourse. If a creditor can show that “cause” exists to “lift” the stay as to its particular claim against the debtor, the bankruptcy court will lift the stay to allow the creditor to continue its action. “Cause” is not defined by the Bankruptcy Code. So what constitutes sufficient “cause” to interrupt the debtor’s breathing spell?
The Bankruptcy Court for the Northern District of Illinois recently reviewed the Seventh Circuit’s standard for “cause” in considering whether the stay should be lifted to allow the Sierra Club to continue litigation against Midwest Generation, LLC (Midwest), an operator of several coal-fired plants in Illinois and one of the debtors in the Edison Mission Energy bankruptcy cases. After considering the potential harms and benefits to both the debtor and the creditor, the court found that relief from the stay was warranted.
The Sierra Club, the oldest environmental organization in the US, commenced a regulatory proceeding against Midwest before the Illinois Pollution Control Board in December 2012. In its complaint, the Sierra Club asserted that Midwest’s coal plants were emitting sulfur dioxide in levels that violated Illinois law because the amounts exceeded the Environmental Protection Agency’s standards and therefore caused, or threatened to cause, “air pollution” as prohibited by Illinois law. In the proceeding, the Sierra Club sought (a) a determination that Midwest was violating state environmental laws, (b) entry of an order compelling Midwest to comply with Illinois laws regarding its sulfur dioxide emissions, and (c) an award of civil penalties.
Midwest, along with affiliated entities, filed for bankruptcy later that same month at the end of 2012. The automatic stay went into place immediately, requiring Sierra Club to stand down from its proceeding against Midwest. In October 2013, the Sierra Club filed a motion seeking an order (1) determining that the automatic stay did not apply to its regulatory proceeding pursuant to Bankruptcy Code section 362(b)(4), or (2) if the stay did apply, finding that “cause” existed pursuant to Bankruptcy Code section 362(d)(1) to lift the stay to allow the Sierra Club to proceed against Midwest.
The court first determined that the Sierra Club could not get around the automatic stay pursuant to the “police power exception” contained in Bankruptcy Code section 364(b)(4). That section provides that the automatic stay does not apply to actions brought by governmental units and relating to matters of public safety and health. The bankruptcy court held that because the Sierra Club, and not a governmental unit, was prosecuting the regulatory action, the police power exception did not immunize the regulatory proceeding from the automatic stay.
Seventh Circuit’s Standard for “Cause”
The bankruptcy court then considered whether the Sierra Club had demonstrated that “cause” existed to lift the stay pursuant to Bankruptcy Code section 362(d)(1). The bankruptcy court reviewed the Seventh Circuit’s three-part balancing test in determining whether cause exists, considering:
1) Whether any great prejudice to either the bankruptcy estate or the debtor will result from continuation of the civil suit;
2) Whether the hardship to the [non-bankruptcy party] by maintenance of the stay considerably outweighs the hardship of the debtor; and
3) Whether the creditor has a probability of prevailing on the merits.
In reviewing the first factor, the bankruptcy court noted that Midwest would be required to comply with environmental regulations when it emerged from bankruptcy and the Sierra Club’s proceeding would simply expedite compliance with these regulations. Midwest asserted that granting relief from the stay could disrupt its reorganization efforts, but the court disagreed, noting that Midwest and the other debtors were multi-national corporations with access to resources, even in bankruptcy, to allow them to address the Sierra Club’s action and also attend to their restructuring process. This factor may have gone the other way had the debtors been in more dire straights in their reorganization efforts.
With respect to the second factor, the Sierra Club asserted that the hardship to it and Illinois residents would be significant absent relief from the stay, because the Sierra Club would be unable to protect the local residents and ensure compliance with environmental regulations. The court agreed, deeming it important for the sake of public health to determine sooner rather than later if the debtor was emitting elevated levels of pollutants into the air.
Finally, the court found that the Sierra Club had a reasonable likelihood of prevailing on the merits in its regulatory proceeding. Based on all three factors, the court held that cause existed to lift the stay to allow the Sierra Club to proceed with its action (prohibiting it only from enforcing any monetary penalty that might be awarded in the proceeding).
While the Bankruptcy Code offers debtors great protections like the automatic stay, these protections are not unlimited. Creditors may seek relief from the stay, and the court will consider the harms and benefits to both the creditor and the debtor in determining whether “cause” exists.