Contributed by Adam Lavine
Although an Italian bankruptcy court approved Parmalat’s plan of reorganization (or Concordato) in 2005, litigation arising from Parmalat’s 2004 collapse continues to make its way through the courts. As a result of a recent decision by the United States Court of Appeals for the Second Circuit, resolution of certain state law malpractice and fraud claims initiated by a Parmalat subsidiary and Parmalat’s Extraordinary Commissioner (the Italian equivalent of a chapter 11 trustee) will be further delayed as the case is transferred from federal district court to an Illinois state court.
The litigation began in September 2004 when Parmalat filed its state law claims in Illinois state court. The Defendants, which include the pre-bankruptcy auditors of Parmalat, later removed the case to federal court, and the Judicial Panel on Multidistrict Litigation transferred the case to the Southern District of New York. Although the District Court granted summary judgment to the Defendants, Parmalat appealed to the Second Circuit, arguing that the District Court erred by not abstaining from the case pursuant to the mandatory abstention provision of 28 U.S.C. 1334(c)(2). In Parmalat I, the Second Circuit vacated the District Court’s decision not to abstain, remanded the case for a determination of whether the cases could be “timely adjudicated” in state court, and directed the District Court to apply a new test for timely adjudication formulated by the Second Circuit. On remand, the District Court again concluded that mandatory abstention did not apply. In Parmalat II, the most recent decision in this eight-year litigation, the Second Circuit reversed the decision of the District Court and held that mandatory abstention applied to the case because the claims at issue could still be “timely adjudicated” in state court, even though the transfer might further prolong the litigation.
Pursuant to section 1334(c)(2), a district court is required to abstain from hearing a state law cause of action “related to” a bankruptcy case if, among other things, “an action is commenced, and can be timely adjudicated, in a state forum of appropriate jurisdiction” (emphasis added). Although timely adjudication is only one of the requirements that must be met for mandatory abstention to apply, timeliness was the only requirement at issue in Parmalat II.
As noted above, the Second Circuit announced the test for timely adjudication in Parmalat I. Under the Parmalat I test, courts must consider the following factors when evaluating section 1334(c)(2) timeliness:
- the backlog of the state court’s calendar relative to the federal court’s calendar;
- the complexity of the issues presented and the respective expertise of each forum;
- the status of the title 11 bankruptcy proceeding to which the state law claims are related; and
- whether the state court proceeding would prolong the administration of the estate.
Notwithstanding the Second Circuit’s apparently structured four factor test, on remand the District Court chose not to engage in a formulaic analysis of all four factors. Instead, the District Court determined that the claims could not be “timely adjudicated” in state court because, among other things, (i) it would take the state court “an extraordinary amount of time merely to familiarize itself with the record,” and (ii) the state court would be “confronted with attempts to relitigate issues,” such as the District Court’s many discovery-related rulings.
In Parmalat II, the Second Circuit made it clear that it intended that its “timely adjudication” test requires a thorough application of all four of the test’s factors and evaluated each factor in turn. With respect to the first factor, the Second Circuit concluded that the District Court overestimated the time it might take an Illinois court to resolve the litigation. Nevertheless, the Second Circuit did in fact concede that the first factor weighed against mandatory abstention given that transferring the case would likely result in a delay.
With respect to the second factor, the Second Circuit found that the complexity of the issues presented and the respective expertise of each forum cut in favor of mandatory abstention. In reaching this conclusion, the Second Circuit noted that “one of the key issues in the case – the defense of in pari delicto – is a matter of Illinois state law and there is some doubt as to the nature and reach of the defense.” In this way, the Second Circuit chose to focus on the complexity of the legal issues, finding that a state court was better equipped to resolve them efficiently, whereas the District Court had focused on the complexities of the factual record.
As to the third factor, which concerns the “status of the title 11 bankruptcy proceeding,” the Second Circuit has previously noted that courts must consider whether the parties need the state law claims to be quickly resolved in light of the ongoing bankruptcy case. See Parmalat I, 639 F.3d at 581. In the case of Parmalat, the title 11 proceeding is a section 304 case ancillary to Parmalat’s foreign main proceeding. Bankruptcy courts overseeing section 304 cases (the precursor to chapter 15 cases) are not tasked with overseeing reorganization or liquidation of the estate, and thus the Second Circuit found that Parmalat’s section 304 case did not require a swift resolution of the state law causes of action.
Similarly, with respect to the fourth factor, the Second Circuit found that resolution of the state law claims (whether in federal court or state court) would not prolong Parmalat’s foreign main proceeding and would have no impact on the ability of the reorganized Parmalat to pay its creditors in accordance with the Concordato. Having determined that three of the four factors cut in favor of mandatory abstention, the Second Circuit remanded the case to the District Court with instructions to transfer the case to Illinois so that it could be heard by an Illinois state court.
The Second Circuit’s application of the four factor Parmalat test sends a significant message to both courts and litigants. Specifically, the Second Circuit has indicated that when it comes to assessing whether a cause of action can be “timely adjudicated” in state court, the key inquiry is not necessarily the amount of time it will take for a state court to resolve the matter. This is a rather counterintuitive notion, but the Second Circuit succinctly illustrated the point as follows:
The factors are ultimately interrelated: an action might be “timely adjudicated” in state court, despite some substantial delay, where the delay has little or no effect on the bankruptcy estate which creates the federal interest…. Conversely, even a relatively brief delay might make a state court adjudication untimely where the state action substantially affects the bankruptcy estate, or where the estate’s resolution is contingent upon the state action.
Through these words, the Second Circuit is warning both courts and litigants not to place too much emphasis on the time it might take for a state court to resolve the dispute. After all, according to the Second Circuit, the import of any delay must not be measured according to the calendar, but according to the relevant federal interests as expressed by the four factor Parmalat test.