When a defendant in a lawsuit files for bankruptcy, the bankruptcy court will not necessarily have jurisdiction over the pending litigation. The court must determine that the case is either “core” or “related” to the bankruptcy. In Ammini v. Labgold (In re Labgold), Case No. 14-01043, decided on June 16, 2015, the Bankruptcy Court for the Eastern District of Virginia determined that it no longer had jurisdiction to adjudicate litigation involving the debtor—even though the litigation fell within the court’s “core” jurisdiction when first brought to the bankruptcy court—in part because the debtor/defendant had been denied a discharge under the Bankruptcy Code. The bankruptcy court therefore dismissed the adversary proceeding against the debtor/defendant and directed the plaintiffs to proceed with the case in state court.

Background

In the Labgold case, the debtor/defendant was the chief executive officer and a director of Antara Biosciences, Inc., a company located in California. Former employees of Antara had filed an action in state court in California, alleging that the defendant engaged in a series of improper, self-dealing transactions in connection with the wind-down of Antara’s business affairs. After the defendant filed for bankruptcy, the California litigation was stayed. The former employees then filed an adversary proceeding seeking adjudication by the Bankruptcy Court of certain state law claims, including among others breach of fiduciary duty claims. The employees sought the entry of a money judgment by the Bankruptcy Court.

At the same time that the former employees’ adversary proceeding was pending, the United States Trustee filed its own adversary proceeding, objecting to the debtor’s discharge of debts pursuant to section 727 of the Bankruptcy Code. The United States Trustee’s case proceeded more quickly and, before trial was completed in the former employees’ case, the Bankruptcy Court entered an order in the U.S. Trustee’s case denying the debtor a discharge of his debts. With that ruling, the only claims remaining before the Bankruptcy Court were those of the former employees asserted in their adversary proceeding. The former employees asked the Bankruptcy Court to consider overseeing their case through conclusion, and the debtor asked that the case be dismissed, with the claims to be considered in the California litigation.

Lack of Subject Matter Jurisdiction

In considering whether it could continue to oversee the former employees’ adversary proceeding, the Bankruptcy Court first analyzed whether the proceeding could be classified as either a “core” or “related” proceeding. The Bankruptcy Court concluded that the proceeding was: (1) not “core” within the meaning of 28 U.S.C. § 157(b) because it involved only the adjudication of state law claims that existed outside of the bankruptcy; and (2) not “related” to the bankruptcy case within the meaning of 28 U.S.C. § 157(c) because the outcome of the case would have no impact on the bankruptcy estate, as the creditor body as a whole would be unaffected.

After determining that it no longer had jurisdiction over the adversary proceeding as a core proceeding or a non-core related proceeding, the Bankruptcy Court noted that a number of courts have held that a bankruptcy court may have continuing jurisdiction in section 523 cases notwithstanding a denial or waiver of the debtor’s discharge. Whether the continued exercise of jurisdiction is appropriate depends on judicial economy, fairness and convenience to the litigants, and the degree of difficulty of the related legal issues involved. Considering those factors, the Court found, among other things, that neither the former employees nor the Debtor would be unfairly prejudiced by a return of the remaining claims to California state court, and that adjudication of the issues underlying the proceeding did not require any special bankruptcy expertise.

Accordingly, the Bankruptcy Court concluded that it lacked jurisdiction over the adversary proceeding.

Abstention from Hearing the Adversary Proceeding

The Bankruptcy Court also determined in the alternative that, even if it did have continuing subject matter jurisdiction, in the absence of any bankruptcy issues left to decide, it would exercise its discretion under 28 U.S.C. § 1334(c)(1) to abstain from hearing the adversary proceeding. The Court observed that the state court was “clearly better situated to decide the remaining State law issues in the case,” and held that “comity for the State court and its expertise on State law demands that this Court abstain.”