# LSC Wind Down, LLC

> United States Bankruptcy Court, D. Delaware · October 7, 2020

URL: https://www.frixlaw.com/law-library/cases/10455951

## Case

- **Court:** United States Bankruptcy Court, D. Delaware
- **Decided:** October 7, 2020
- **Opinion:** 100trialcourt
- **Cited by:** 0 later opinions in the Frix Law Library

## Citator (automated)

- No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases.
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/10455951

## How later opinions describe it (automated extraction)

- holding that filing of adversary proceeding against debtors did not violate automatic stay and collecting cases
- holding that adversary proceeding in home bankruptcy court did not violate automatic stay and noting that it was akin to filing a proof of claim
- finding pre- petition contract damages claim for breach of a letter agreement was not subject to res judicata because it could not have been brought in prior adversary proceeding that was dismissed
- recognizing rescission as an equitable remedy

## Opinion text

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE
In re: ) Chapter 11
)
FOREVER 21, INC., et al., )
) Case No. 19-12122 (MFW)
Debtors. ) Jointly Administered
__________________________________ )
)
ALLIED DEVELOPMENT OF ALABAMA LLC, )
)
Plaintiff, )
)
v. )
)
FOREVER 21, INC., et al., and ) Adv. No. 19-50897
JATIN MALHOTRA )
)
Defendants. )
MEMORANDUM OPINION1
Before the Court is a Motion to Dismiss filed by Forever 21,
Inc., et al. (the “Debtors”) and joined by Jatin Malhotra
(collectively, the “Defendants”) for failure to state a claim
upon which relief can be granted. Allied Development of Alabama,
LLC (“Allied”) opposes the Motion. For the reasons stated below,
the Motion will be denied.
1 The Court is not required to state findings of fact or
conclusions of law pursuant to Rule 7052 of the Federal Rules of
Bankruptcy Procedure. Instead, the facts averred in the
Complaint must be accepted as true for purposes of this Motion to
Dismiss. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009).
I. FACTUAL BACKGROUND
Allied is the owner of a retail center in Alabama. Between
October 2017 and March 2018, Allied and the Debtors’ Vice
President of Real Estate, Jatin Malhotra, negotiated the terms of
a lease for a store at the center. During these negotiations,
the Debtors sought several concessions from Allied, including an

agreement to reimburse the Debtors for making improvements to the
premises. Before responding to the Debtors’ request for
reimbursement, Allied asked for the Debtors’ sales projections
for the store. Mr. Malhotra represented to Allied’s manager,
David Mott, that the Debtors had a comparable store in Mobile,
Alabama, which had annual sales in 2017 of $6 million and that
the Debtors projected at least the same amount of sales at the
store in Allied’s retail center (“the Eastern Shore Store”).
Based on these representations, Allied contends that it
abandoned a tentative agreement with another prospective tenant
and entered into the Lease Agreement with the Debtors for the

Eastern Shore Store in March 2018. Rent under the lease was
dependent on the Debtors’ gross sales at the Eastern Shore Store.
Consistent with the parties’ negotiations and the rider to the
Lease Agreement, Allied reimbursed the Debtors more than $2
million for improvements to the leased premises.

2
After the parties entered into the Lease Agreement, Mr.
Malhotra provided revised projections showing that the Eastern
Shore Store would generate $7 million in annual sales. During
the period that the Eastern Shore Store was open for business,
however, the store significantly underperformed the Debtors’
projections, generating only $1.6 million in gross sales between

October 2018 and September 30, 2019. In addition, after entering
into the Lease Agreement with the Debtors, Allied discovered that
the Debtors’ Mobile Store had generated only $2 million in gross
sales during 2017, not $6 million as Mr. Malhotra had claimed.

II. PROCEDURAL BACKGROUND
On September 29, 2019, the Debtors filed voluntary petitions
for relief under chapter 11. The Debtors advised Allied that
they intended to sell or reject the Lease Agreement because of
the Eastern Shore Store’s poor performance.
On November 22, 2019, Allied commenced this adversary

proceeding against the Defendants. Counts I and II plead claims
for damages against the Debtors and Mr. Malhotra for fraudulent
inducement and negligent misrepresentation, respectively. Count
III also alleges fraudulent inducement but requests rescission of

3
the Lease Agreement as the remedy.2 Count IV pleads an unjust
enrichment claim against the Debtors for the improvement costs
incurred by Allied. Count V seeks a declaratory judgment stating
that: 1) Mr. Malhotra has indemnification rights owed to him from
the Debtors, 2) the Debtors’ liabilities stemming from this
proceeding are covered by the Debtors’ insurance policies, and 3)

the proceeds of the relevant insurance policies are not property
of the Debtors’ estates.
On December 26, 2019, the Debtors filed the Motion to
Dismiss for failure to state a claim. On January 17, 2020,
Allied filed its Brief in Response, and on January 31, 2020, the
Debtors filed their Reply Brief. Mr. Malhotra joined the
Debtors’ Motion and briefs. The matter is now ripe for decision.

III. JURISDICTION
This Court has jurisdiction over this adversary proceeding.
28 U.S.C. §§ 1334(b) and 157(b) & (c). Allied asserts that some

of its claims are non-core, and Allied does not consent to the

2 The heading of Count III states that the cause of action is
rescission, but under Alabama contract law, rescission is not a
cause of action. It is a potential remedy for fraudulent
inducement and negligent misrepresentation. See, e.g., Hillcrest
Ctr., Inc. v. Rone, 711 So. 2d 901, 907 (Ala. 1997), as modified
on denial of reh’g (Nov. 14, 1997) (characterizing rescission as
one available remedy for fraudulent inducement).
4
entry of final orders for its non-core claims but reserves the
right to provide consent at a later date.3 The Defendants
consent to the entry of a final order in connection with this
Motion.4
Even without consent of all parties, however, the Court has
the power to enter an order on a motion to dismiss even if the

matter is non-core and it has no authority to enter a final order
on the merits. See, e.g., Welded Constr., L.P. v Prime NDT
Servs., Inc. (In re Welded Constr., L.P.), 605 B.R. 35, 37
(Bankr. D. Del. 2019); Burtch v. Owlstone, Inc. (In re Advance
Nanotech, Inc.), Adv. Proc. No. 13–51215, 2014 WL 1320145, at *2
(Bankr. D. Del. Apr. 2, 2014); O’Toole v. McTaggart (In re
Trinsum Grp., Inc.), 467 B.R. 734, 739-40 (Bankr. S.D.N.Y.
2012)).

IV. LEGAL STANDARD
A motion to dismiss pursuant to Rule 12(b)(6), as

incorporated by Bankruptcy Rule 7012, tests the factual
sufficiency of a plaintiff’s complaint. Bell Atl. Corp. v.

3 Allied also “demands and explicitly reserves its right to
jury trial with respect to all claims triable.” Adv. D.I. 1 at ¶
6.
4 D.I. 4 at n.3. Because he joined the Debtors’ Motion, Mr.
Malhotra has also consented.
5
Twombley, 550 U.S. 544, 555 (2007). To survive a Rule 12 (b) (6)
motion to dismiss, a plaintiff’s complaint must “contain
sufficient factual content, accepted as true, to state a claim
for relief that is plausible on its face.” Ashcroft v. Iqbal,
556 U.S. 662, 678 (2009) (quoting Twombley, 550 U.S. at 555).
A claim is plausible on its face if it contains “enough
facts to raise a reasonable expectation that discovery will
reveal evidence of the necessary elements of a claim.” Phillips
v. Cnty. of Allegheny, 515 F.3d 224, 234 (3d Cir. 2008).
“Threadbare recitals of the elements of a cause of action,
supported by conclusory statements, do not suffice.” Iqbal, 556
U.S. at 678.
In considering a motion to dismiss, the allegations in the
complaint must be construed “in the light most favorable to the
plaintiff.” Igbal, 556 U.S. at 678; Burtch v. Milberg Factors,
Inc., 662 F.3d 212, 221 (3d Cir. 2011). Determining whether a
complaint states a plausible claim is a context-specific analysis
that is informed by the court’s “judicial experience and common
sense.” Iqbal, 556 U.S. at 679.
“Rule 12(b) (6) authorizes a court to dismiss a claim on the
basis of a dispositive issue of law.” Neitzke v. Williams, 490
U.S. 319, 326 (1989).

V. DISCUSSION
The Debtors raise two legal issues that they say warrant
dismissal of the Complaint: (1) the claims Allied asserts in the
adversary proceeding are all pre-petition claims for damages that
are more properly brought in the claims reconciliation process,
and (2) Allied is violating the automatic stay by seeking to

recover its pre-petition claims. Even if the complaint should
not be dismissed, the Debtors contend that it should be stayed
under section 105 because it is disruptive to the bankruptcy
case.
Allied responds that its claims are properly brought,
because they fit within the definitions in Rule 7001 of what
actions must be brought as adversary proceedings. Specifically,
Allied notes that its complaint includes equitable claims and
claims against a non-debtor. Further, Allied notes that the
majority of courts conclude that there is no violation of the
stay when an action is brought as an adversary proceeding in a

debtor’s bankruptcy case. Finally, Allied argues that the
Debtors have not established cause for the issuance of a stay
under section 105.
A. Rule 7001
The Debtors argue that the complaint should be dismissed
because it is procedurally improper under Bankruptcy Rule 7001.
7
The Debtors assert that Rule 7001 does not permit the filing of
an adversary proceeding merely to recover a pre-petition claim.
According to the Debtors, Allied’s causes of action,
including its actions requesting equitable relief, all seek to
recover money damages for a pre-petition claim. In essence,
Allied is simply seeking to recover the $2 million in lease

improvements that it agreed to pay allegedly because of the
Debtors’ fraudulent misrepresentations about anticipated sales at
the Eastern Shore Store. Because Allied has an adequate remedy
at law, the Debtors assert it cannot assert an equitable claim,
which is its only basis for filing an adversary proceeding.
Instead, the Debtors contend that Allied must pursue its claims
through the claims reconciliation process.
Allied responds that the claims in its complaint all fit
within the definitions in Rule 7001 of the types of proceedings
that must be brought by adversary proceeding. Specifically,
Allied argues that it is asserting claims to recover money,

claims to determine interests in property, claims for equitable
relief, and claims for a declaratory judgment. Fed. R. Bankr. P.
7001(1), (2), (7) & (9). Thus, Allied asserts that its adversary
proceeding against the Debtors is the only procedurally viable
method it has to obtain the relief it seeks. See, e.g., In re
WorldCorp, Inc., 252 B.R. 890, 895 (Bankr. D. Del. 2000) (“Rule
8
7001 designates ten types of actions which must be brought as
adversary proceedings in bankruptcy cases.”).
1. Counts I and II Claims for Damages
In Counts I and II, Allied asserts claims for monetary
damages against the Debtors and Mr. Malhotra for fraud in the
inducement and negligent misrepresentation.

The Debtors argue that many courts conclude that Rule 7001
does not permit a creditor to commence an adversary proceeding
seeking money damages for pre-petition conduct; instead, the
creditor must file a proof of claim. See, e.g., Toscano v. The
RSH Liquidating Trust (In re RS Legacy Corp.), Adv. Proc. No.
16–51033, 2017 WL 3837294, at *2 (Bankr. D. Del. Aug. 31, 2017)
(“because Plaintiff seeks monetary damages from the funds in the
estate, the procedurally proper route must commence through the
claims administrative process”); Evergreen Solar, Inc. v.
Barclays PLC (In re Lehman Bros. Holdings, Inc.), Adv. Proc. No.
08-01633, 2011 WL 722582, at *7–8 (Bankr. S.D.N.Y. 2011)

(dismissing adversary proceeding asserting pre-petition claim for
breach of contract because the claim should have been asserted
through the claims allowance process); Scott v. Aegis Mortg.
Corp. (In re Aegis Mortg. Corp.), Adv. Proc. No. 08–50237, 2008
WL 2150120, at *6 (Bankr. D. Del. May 22, 2008) (holding that an
adversary proceeding for damages arising from pre-petition
9
conduct was improper because the proceeding did not fall within
any of the ten categories of Rule 7001); DBL Liquidating Trust v.
P.T. Tirtamas Majutama (In re Drexel Burnham Lambert Grp.,
Inc.), 148 B.R. 993, 998 (Bankr. S.D.N.Y. 1992) (finding pre-
petition contract damages claim for breach of a letter agreement
was not subject to res judicata because it could not have been

brought in prior adversary proceeding that was dismissed).
Those courts conclude that claims for damages against a
debtor arising from pre-petition conduct cannot be brought by an
adversary proceeding because they are not included in the ten
categories of adversary proceedings listed in Rule 7001. Aegis,
2008 WL 2150120, at *6; Drexel Burnham, 148 B.R. at 998 (citing
Dade Cnty School Dist. v. Johns–Manville Corp. (In re
Johns–Manville Corp.), 53 B.R. 346, 352–55 (Bankr. S.D.N.Y.
1985)). Rather, they conclude that creditors should resolve pre-
petition money damages claims through the claims reconciliation
process by filing proofs of claims.

The Court disagrees with the suggestion that there is a per
se rule against resolving a pre-petition claim for damages in the
adversary process. Nothing in the express language of Rule 7001
prohibits it; instead, Rule 7001 simply lists claims that must be
prosecuted as adversary proceedings. In fact, there are several
instances where pre-petition claims are adjudicated in adversary
10
proceedings. While the Comment to Rule 7001 does note that
proofs of claim and objections thereto are governed by the claims
allowance process in Rules 3001 et seq., it also states that when
an objection to a claim is joined with a demand for relief of the
kind specified in Rule 7001, it must be brought as an adversary
proceeding. See Fed. R. Bankr. P. 3001, comment; Fed. R. Bankr.

P. 3007(b) (“A party in interest shall not include a demand for
relief of a kind specified in Rule 7001 in an objection to the
allowance of a claim, but may include the objection in an
adversary proceeding.”).
Further, Rule 7001(10) provides that actions which are
removed from other courts are adversary proceedings.5 Removed
actions typically assert pre-petition claims against the debtor.
Nonetheless, they are resolved in the adversary proceeding, not
in the claims resolution process.
Even if Rule 7001 were read to require that an action fit
into one of the categories in order to warrant an adversary

proceeding, Allied argues that the claims in Counts I and II fit
within Rule 7001(1) as “a proceeding to recover money or

5 Rule 7001(10) states that “a proceeding to determine a claim
or cause of action removed under 28 U.S.C. § 1452” constitutes an
adversary proceeding. Fed. R. Bankr. P. 7001(10).
11
property.”6 The claims against Mr. Malhotra, who is not a debtor
in this case, cannot be asserted by the filing of a proof of
claim in this bankruptcy case and properly fit within Rule
7001(1). While the Debtors contend that Rule 7001(1) does not
include pre-petition damages claims against a debtor, the Rule
does not expressly state that. Further, because the claims

against the Debtors are based on the same facts and issues of law
that support the claims against Mr. Malhotra, the Court finds
that they should be heard together in this adversary proceeding
pursuant to Rule 7042.7
Similarly, the claims for equitable relief brought in Counts
III, IV, and V are based on the same facts and issues of law that
support the claims in Counts I and II. For the reasons stated in
Parts 2 and 3 below, the equitable claims must be brought by
adversary proceeding. Thus, the Court concludes that the claims
against the Debtors in Counts I and II should be consolidated
with the other claims in the Complaint under Rule 7042 and heard

in this adversary proceeding. See, e.g., RS Legacy, 2017 WL
6 Rule 7001(1) provides in full that “a proceeding to recover
money or property, other than a proceeding to compel the debtor
to deliver property to the trustee, or a proceeding under §
554(b) or § 725 of the Code, Rule 2017, or Rule 6002” shall be
brought by an adversary proceeding. Fed. R. Bankr. P. 7001(1).
7 Fed. R. Civ. P. 42, made applicable in adversary proceedings
by Rule 7042, allows the Court to consolidate matters that
involve a common question of law or fact.
12
3837294, at *3 (acknowledging adversary may be treated as
informal proof of claim but dismissing it because it was filed
after the bar date); Wilson v. Residential Cap. (In re
Residential Cap.), Adv. Pro. No. 12-01936, 2014 WL 3057111, at *7
(Bankr. S.D.N.Y. July 7, 2014) (concluding that pre-petition
damages claim included in adversary proceeding with request for

equitable relief would be treated as an informal proof of claim).
2. Counts III & IV Claims for Equitable Relief
Count III’s fraudulent inducement claim seeks rescission of
the Lease Agreement, and Count IV’s unjust enrichment claim seeks
restitution for the improvement costs Allied incurred. Under
applicable state law both are claims for equitable relief. See,
e.g., Ex parte Montgomery Cnty. D.O.H.R, 10 So. 3d 31, 39 (Ala.
Civ. App. 2008) (recognizing rescission as an equitable remedy);
Avis Rent A Car Systems, Inc. v. Heilman, 876 So. 2d 1111, 1123
(Ala. 2003) (holding that unjust enrichment is an equitable
remedy).

Pre-petition claims seeking equitable relief, such as
restitution and unjust enrichment, are expressly required to be
brought by adversary proceedings under Rule 7001. Fed. R. Bankr.
P. 7001(7) (adversaries include “a proceeding to obtain an
injunction or other equitable relief”).

13
The Debtors argue, however, that Allied’s claims for
equitable relief are improper because equitable relief is only
appropriate where there is no remedy at law. In this case, the
Debtors note that Allied asserts such a legal claim for damages
in Counts I and II. Further, the Debtors contend that Allied’s
rescission and restitution claims themselves could result in a

monetary award, and therefore, the actions are “claims” which
must be pursued in the claims reconciliation process. See 11
U.S.C. § 101(5) (defining claims to include “right to an
equitable remedy for breach of performance if such breach gives
rise to a right to payment”). Thus, the Debtors contend that
determining whether the adversary proceeding is proper hinges on
whether the complaint asserts “claims” as defined in section
101(5). If the causes of action assert “claims,” then the
Debtors argue that they cannot be brought in an adversary
proceeding but must be brought by filing a proof of claim.
The Court disagrees with the Debtors’ analysis. The

definition of claim in section 101(5) is not relevant to the
determination of whether that claim can be brought in an
adversary proceeding. Rather, it is the language of Rule 7001
that is conclusive. The express language of Rule 7001 provides
that requests for equitable relief must be brought by adversary
proceeding. Fed. R. Bankr. P. 7001(7).
14
Further, the Court cannot at this stage of the proceedings
dismiss Allied’s equitable claims, because it cannot conclude
whether Allied has an adequate remedy at law. It is, therefore,
proper for Allied to plead alternatively both a legal damages
claim and claims for equitable relief. In addition, the mere
fact that Allied could receive a monetary award on some of those

equitable claims does not transform those claims into legal
claims. Even though an equitable claim may result in a monetary
award, courts have concluded that it is properly brought as an
adversary proceeding. See, e.g., Conn v. Dewey & LeBoeuf LLP (In
re Dewey & LeBoeuf LLP), 487 B.R. 169, 176 (Bankr. S.D.N.Y. 2013)
(concluding that WARN Act claims for unpaid pre-petition wages
could be asserted by adversary proceeding because the claims
sought restitution which is equitable relief); Watson v. TSC
Global, Inc. (In re TSC Global, LLC), Adv. Proc. No. 12-50119,
2013 WL 6502168, *3 (Bankr. D. Del. June 26, 2013) (holding that
WARN Act claim was an equitable claim even though the Plaintiffs

sought to recover back pay).
Thus, the Court concludes that Counts III and IV are
properly brought in this adversary proceeding under Rule 7001(7)
and dismissal of them is not warranted.

15
3. Count V Claim for Declaratory Judgment
In Count V, Allied seeks a declaratory judgment that Mr.
Malhotra’s indemnification rights are covered by the Debtors’
director and officer insurance policies and that those policies
are not property of the estate.
The Debtors argue that only declaratory relief which relates

to one of the types of proceedings expressly listed in Rule
7001(1) - (8) is properly brought as an adversary proceeding
under Rule 7001(9). Fed. R. Bankr. P. 7001(9) (“a proceeding to
obtain a declaratory judgment relating to any of the foregoing”).
The Debtors argue that Count V’s declaratory relief does not
relate to any of the other provisions in Rule 7001.8
As the Court has held above, however, Counts I - IV are
properly brought against Mr. Malhotra and the Debtors under Rule
7001(1) and (7). The request for declaratory relief seeks a
determination that the Debtors have an obligation to indemnify
Mr. Malhotra for those other claims and that the Debtors’

insurance covers those claims. Thus, the Court concludes that
the declaratory relief does relate to claims brought under Rule
7001(1) and (7).

8 The Debtors also argue that the request for declaratory
relief ought to be brought by motion, without any citation. In
light of the express language of Rule 7001(9), the Court rejects
this argument.
16
In addition, in seeking a determination that the insurance
policies are not property of the estate, Count V clearly relates
to an action under Rule 7001(2) which requires an adversary
proceeding for an action to determine an interest in property.
Thus, the Court concludes that Count V is expressly required to
be brought by an adversary proceeding under Rule 7001(9).

B. The Automatic Stay
The Debtors argue that Allied’s adversary proceeding should
be dismissed because it undermines the policy inherent in the
automatic stay. The Debtors note that “the automatic stay is one
of the fundamental debtor protections provided by the bankruptcy
laws. It gives the debtor a breathing spell from his creditors.”
In re Wedgewood Realty Group, Ltd., 878 F.2d 693, 696 (3d Cir.
1989) (quoting S. Rep. No. 989, 95th Cong., 2d Sess. 54,
reprinted in 1978 U.S.C.C.A.N. 5787, 5840).
Section 362(a) of the Bankruptcy Code provides that a
bankruptcy petition “operates as a stay, applicable to all

entities, of . . . the commencement or continuation . . . of a
judicial . . . action or proceeding against the debtor that was
or could have been commenced before the commencement of the case
. . . or to recover a claim against the debtor that arose before
the commencement of the case . . . [or] any act to obtain
possession of property of the estate . . . or to exercise control
17
over property of the estate.” 11 U.S.C. § 362(a). The Debtors
contend that the filing of the adversary proceeding violates that
provision. See, e.g., In re Penny, 76 B.R. 160, 161 (Bankr. N.D.
Ca. 1987) (concluding that it was nonsense for creditor to
believe it could circumvent the automatic stay by filing an
adversary proceeding asserting a pre-petition claim).

Even if filing the adversary proceeding did not violate the
stay, the Debtors contend that the Court must still make a
determination whether relief from the stay would be appropriate
before allowing the litigation to proceed. In re Sciortino, 114
B.R. 423, 427 (Bankr. E.D. Pa. 1990). The Debtors assert that
Allied has failed to meet its burden of showing that cause exists
for lifting the automatic stay.
Allied argues that its adversary proceeding does not violate
the automatic stay because not only is the filing of its
adversary proceeding against the Debtors in the Debtors’ home
bankruptcy court permitted, it is expressly required by Rule

7001.
The Court rejects the Debtors’ arguments and concludes, as
have the majority of courts, that “the Code implicitly permits
the filing of suit in the bankruptcy court against a debtor
without violating the automatic stay.” Nat’l City Bank v.
Lapides (In re Transcolor Corp.), 296 B.R. 343, 358 (Bankr. D.
18
Md. 2003) (holding that filing of adversary proceeding against
debtors did not violate automatic stay and collecting cases).
See also Civic Center Square, Inc. v. Roxford Foods, Inc. (In re
Roxford Foods, Inc.), 12 F.3d 875, 878 (9th Cir. 1993) (holding
that the automatic stay did not apply to suit commenced in the
bankruptcy court where the bankruptcy case was pending);

Cellceutix Corp. v. Nickless (In re Formatech, Inc.), 496 B.R.
26, 35 (Bankr. D. Mass. 2013) (“agree[ing] with the majority view
that the automatic stay does not prohibit the commencement of an
adversary proceeding against a debtor (or its trustee) in the
bankruptcy court”); Charan Trading Corp. v. Uni-Marts, LLC (In re
Uni-Marts, LLC), 399 B.R. 400, 418 (Bankr. D. Del. 2009) (holding
that adversary proceeding in home bankruptcy court did not
violate automatic stay and noting that it was akin to filing a
proof of claim). Thus, the Court concludes that Allied’s claims
in the adversary proceeding against the Debtors are not barred by
the automatic stay.

Further, there is no stay of the claims against Mr.
Malhotra. The automatic stay only protects debtors, not non-
debtor parties. Brown v. Jevic, 575 F.3d 322, 328 (3d Cir.
2009); McCartney v. Integra Nat. Bank N., 106 F.3d 506, 510 (3d
Cir. 1997). It is true that some courts have extended section
362(a)’s protections to non-debtors in “unusual circumstances,”
19
such as where “there is such identity between the debtor and the
third-party defendant that the debtor may be said to be the real
party defendant and that a judgment against the third-party
defendant will in effect be a judgment or finding against the
debtor.” McCartney, 106 F.3d at 510 (quoting A.H. Robins Co.,
Inc. v. Piccinin, 788 F.2d 994, 999 (4th Cir. 1986)). “Courts

have also extended the stay to non-debtor third parties where
stay protection is essential to the debtor’s efforts of
reorganization.” McCartney, 106 F.3d at 510.
In this case, neither the Debtors nor Mr. Malhotra have
established grounds for extension of the automatic stay to him.
Accordingly, the automatic stay does not bar Allied’s claims
against Mr. Malhotra.
C. Section 105 Stay
Lastly, the Debtors argue that even if the adversary
proceeding is not dismissed or the automatic stay does not apply,
the Court should stay it pursuant to section 105 to provide them

with breathing room and to allow them to conserve precious
resources. See In re Prewitt, 135 B.R. 641, 643 (9th Cir. B.A.P.
1992); In re Am. Spinning Mills, Inc., 43 B.R. 365, 367 (Bankr.
E.D. Pa. 1984).
Allied argues that the adversary proceeding will not unduly
strain the Debtors’ resources as it is the only adversary
20
proceeding that has been filed against the Debtors.
Section 105 of the Bankruptcy Code states that “[t]he court
may issue any order, process, or judgment that is necessary or
appropriate to carry out the provisions of this title.” 11
U.S.C. § 105(a). “Section 105(a) of the Bankruptcy Code
supplements courts’ specifically enumerated bankruptcy powers by

authorizing orders necessary or appropriate to carry out
provisions of the Bankruptcy Code. However, section 105(a) has a
limited scope. It does not ‘create substantive rights that would
otherwise be unavailable under the Bankruptcy Code.’” In re
Continental Airlines, 203 F.3d 203, 211 (3d Cir. 2000) (quoting
United States v. Pepperman, 976 F.2d 123, 131 (3d Cir. 1992)).
Instead, the bankruptcy court’s powers under section 105(a) can
only be used in furtherance of other provisions of the Code. In
re Joubert, 411 F.3d 452, 455 (3d Cir. 2005).
Generally, courts apply the traditional preliminary
injunction test when deciding whether to issue an injunction

pursuant to section 105(a). Wedgewood, 878 F.2d at 700-01; In re
W.R. Grace & Co., 412 B.R. 657, 665 (D. Del. 2009). Thus, to
obtain injunctive relief under section 105, the Debtors bear the
burden of showing a “substantial likelihood of success on the
merits, irreparable harm to the movant, harm to the movant
outweighs harm to the nonmovant, and injunctive relief would not
21
violate public interest.” Wedgewood, 878 F.2d at 701.
An action to obtain equitable relief, including an
injunction, generally requires an adversary proceeding. Fed. R.
Bankr. P. 7001(7). See, e.g., Residential Cap., 480 B.R. at 538
(stating that debtor must pursue section 105 injunction staying
actions against non-debtors through an adversary proceeding); In

re Irwin, 457 B.R. 413, 423 n.21 (Bankr. E.D. Pa. 2011) (noting
an extension of the automatic stay by a section 105 injunction
requires the initiation of an adversary proceeding); In re The
Fairchild Corp., Bankr. No. 09-10899, 2009 WL 4546581, at *7
(Bankr. D. Del. Dec. 1, 2009) (stating that entry of injunctive
relief requires initiation of an adversary proceeding). Where an
adversary proceeding has already been commenced, however,
injunctive relief in that proceeding can be sought by motion.
See Fed. R. Bankr. P. 7065 (incorporating Fed. R. Civ. P. 65,
which allows motions for preliminary injunctions in civil
actions).

In this case, however, the Debtors did not even file a
motion for an injunction; they simply included a request for a
stay of the action in their briefs in support of their motion to
dismiss. (D.I. 5 at ¶¶ 34-37; D.I. 18 at ¶¶ 25-29.) The request
to extend the stay to Mr. Malhotra was contained in a footnote in
their briefs. (D.I. 5 at n.5; D.I. 18 at n.7.) This is
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procedurally improper. See, e.g., Fairchild Corp., 2009 WL
4546581, at *7 (denying debtor’s request for extension of the
stay contained in its response to motion for determination of
extent of the automatic stay as improper because such relief can
only be obtained by filing an adversary proceeding). Therefore,
the Court will not consider that request.

V. CONCLUSION
For the foregoing reasons, the Court will deny the
Defendants’ Motion to Dismiss.
An appropriate Order is attached.

Dated: October 7, 2020 BY THE COURT:

Mary F. Walrath
United States Bankruptcy Judge

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/10455951. Public record. Not legal advice.