-4-

The Adversary Proceeding Against the Class Action Plaintiffs

On May 7, 2002, the Trustee brought an adversary proceeding
and moved to preliminarily enjoin the Class Action plaintiffs from
prosecuting their suit and to prohibit them from making any
attempts to obtain possession of or control over the proceeds of
the insurance policies. The Trustee also sought a declaration that
the proceeds of the policies are property of the bankruptcy estate
of Marchfirst. The Trustee relied on sections 105(a) and 362 (a) (3)
of the Bankruptcy Code.

Following briefing and oral argument, the bankruptcy court
issued its opinion regarding the Trustee’s motion. The court
denied the relief sought pursuant to § 362(a), the automatic stay
provision, reasoning that the insurance policy proceeds are not
“property of the estate.” However, the court determined that the
Class Action should be enjoined pursuant to § 105(a):

Section 105(a) of the Bankruptcy Code provides in
pertinent part that the “court may issue any order,
process, or judgment that is necessary or appropriate to
carry out the provisions of this title.” In assessing
whether to issue an injunction under § 105(a), the
Seventh Circuit does not require the court to evaluate
the four factors that are usually considered in the
decision to issue an injunction. A “bankruptcy court can
enjoin proceedings in other courts when it is satisfied
that such proceedings would defeat or impair its
jurisdiction over the case before it. In other words,
the court does not need to demonstrate an inadequate
remedy at law or irreparable harm.” Fisher v. Apostolou,

155 F.3d at 882, quoting In re L & S Industries, Inc.,

989 F.2d 929, 932 (7th Cir, 1993).

According to the Seventh Circuit, “in limited
circumstances, the trustee may temporarily block


-9-

According to the Seventh Circuit, a case is “related to” a
bankruptcy “when the dispute ‘affects the amount of property for
distribution [i.e., the debtor’s estate] or the allocation of
property among creditors.

‘” In re Fedpak Sys., Inc., 80 F.3d 207,

213-14 (7th Cir. 1996) (quoting In_re Memorial Estates, Inc., 950

F.2d 1364, 1368 (7th Cir. 1992) and In re Xonics, Inc., 813 F.2d
127, 131 (7th Cir. 1987)).

In Fisher v. Apostolou, 155 F.3d 876 (7th Cir. 1998), the
Seventh Circuit considered the scope of “related to” jurisdiction.
The bankruptcy court’s opinion in the instant case described the
facts and holding of Fisher:

In Fisher, the principals of Lake States Commodities,
Inc. ran a scheme in which they defrauded hundreds of
commodities investors. Actions were commenced in the
District Court for the Northern District of Illinois by
some of the investors against the principals of the
corporation as well as against Gelderman, Inc.
(“Gelderman”), a legitimate registered futures commission
merchant through which the Lake States principals
conducted their trades. The investors alleged violations
of securities and commodities laws and common law fraud.

Ultimately, Gelderman was the only entity from which
anyone would recover damages. See In_re Lake States
Commodities, Inc., 230 B.R. 602 (Bankr. N.D. Ill. 1999).
Involuntary chapter 7 bankruptcy petitions were filed
against Lake States and one of its principals. The cases
were administratively consolidated and orders for relief
were entered. In the bankruptcy case that ensued, the
trustee commenced an adversary proceeding. His complaint
argued that the District Court claims were property of
the estate, or, alternatively, that the District Court
claims were sufficiently “related to” those of the
trustee to support a § 105 injunction against the
District Court plaintiffs, staying their lawsuits until
the trustee completed his pursuit of the same defendants.
The Bankruptcy Court issued an injunction against further
prosecution of the District Court cases. In the order,


-6-

insurance policies would be used to satisfy such a
judgment.

The plaintiffs in the [Class] Action will be
enjoined from pursuing such a judgment. Nevertheless, it
should be pointed out that the Defendants are enjoined
only preliminarily and that as soon as the Trustee has
completed his action, the Defendants may proceed with the
[Class] Action.

Maxwell v. Megliola (In re Marchfirst, Inc.), 288 B.R. 526, 530-33

(Bankr. N.D. Ill. Dec. 16, 2002). The bankruptcy court entered a
written order preliminarily enjoining the Class Action plaintiffs
from prosecuting the Class Action, except for conducting discovery
and any proceedings related to discovery, until the completion of
the Trustee Action.

The Class Action plaintiffs appeal. We have granted Illinois
National and North American’s petition to intervene.

DISCUSSION

This court has jurisdiction over the instant appeals pursuant
to 28 U.S.C. § 158(a) (1). On appeal from an order of the
bankruptcy court, we review the bankruptcy court’s factual findings
under a “clearly erroneous” standard and its conclusions of law de

novo. See In re Smith, 286 F.3d 461, 464-65 (7th Cir. 2002); Fed.

R. Bankr. P. 8013.

Appellants raise the following issue on appeal: “whether the
Bankruptcy Court erred in holding that Section 105(a) of the United
States Bankruptcy Code, 11 U.S.C. § 105(a), empowers the Bankruptcy
Court to block adjudication of a nationwide class action lawsuit,

brought by non-creditors against non-debtors, upon a finding that


-5-

adjudication of claims that are not property of the
estate by petitioning the bankruptcy court to enjoin the
other litigation, if it is sufficiently ‘related to’ her
own work on behalf of the estate. 28 U.S.C. § 1334 (b).
The jurisdiction of the bankruptcy court to stay actions
in other courts extends beyond claims by and against the
debtor, to include ‘suits to which the debtor need not be
a party but which may affect the amount of property in
the bankrupt estate,’ Zerand-BernalGrou Inc. v. Cox, 23
F.3d 159, 161-62 (7th Cir. 1994), or ‘the allocation of
property among creditors.’ In re Memorial Estates, Inc.,
950 F.2d 1364, 1368 (7th Cir. 1992); . . . In re Heath,
115 F.3d 521, 524 (7th Cir. 1997) (‘related to’ means
‘likely to affect).” 155 F.3d at 882.

Here, a suit between third parties will affect the
orderly administration of the estate. If the
shareholders obtain a judgment against the directors and
officers, the insurers will either make a payment to the
plaintiffs or deny coverage. If coverage is denied, the
Trustee and the shareholders will be in pursuit of mostly
the same assets of mostly the same individuals. If the
insurers agree to pay the shareholders, the amount that
{[Marchfirst] may be obliged to indemnify the directors
and officers will be diminished. However, since the
funds available to the directors and officers to pay a
judgment are the same funds available to [Marchfirst] to
indemnify them, a shortfall of funds would affect the
administration of the estate. Furthermore, because the
(Defendants/Class Action Plaintiffs] have not delineated
a dollar figure for damages in their complaint against
the directors and officers, a judgment obtained by the
(Defendants/Class Action Plaintiffs] in the [Class]
Action has the potential effect of leaving no funds
available to pay a judgment obtained by the Trustee in
the Trustee Action.

Section 105 of the Bankruptcy Code and the Seventh
Circuit require this Court to enjoin any related
proceeding which may have an effect on the bankruptcy
case. There is no question that a judgment in the
[Class] Action could have a significant effect on this
bankruptcy estate. If the judgment is $100 million, the
insurance policies maintained by [Marchfirst] would be
wiped out, leaving no insurance proceeds for the Trustee
to recover. Because the amount of damages are not
delineated in the shareholders’ complaint, the
possibility exists that all of the proceeds of the



-~g-
Corp. v. Edwards, 514 U.S. 300, 307 (1995) (citing 28 U.S.C. §
1334(b) and 28 U.S.C. § 157(a)). “Proceedings ‘related to’ the
bankruptcy include (1) causes of action owned by the debtor which
become property of the estate pursuant to 11 U.S.C. § 541, and (2)
suits between third parties which have an effect on the bankruptcy
estate.”> Celotex, 514 U.S. at 307 n.5. The Supreme Court stated
in Celotex:

We agree with the views expressed by the Court of Appeals
for the Third Circuit in Pacor, Inc. v. Higgins, 743 F.2d
984 (1984), that Congress intended to grant comprehensive
jurisdiction to the bankruptcy courts so that they might
deal efficiently and expeditiously with all matters
connected with the bankruptcy estate, and that the
“related to” language of § 1334(b) must be read to give
district courts (and bankruptcy courts under § 157(a))
jurisdiction over more than simply proceedings involving
the property of the debtor or the estate. We also agree
with that court’s observation that a bankruptcy court’s
“related to” jurisdiction cannot be limitless.

514 U.S. at 308 (citations and quotation marks omitted). The Court
observed in a footnote that several courts of appeals had adopted
a broad test for determining the existence of “related to”
jurisdiction--“whether the outcome of [the civil] proceeding could
conceivably have any effect on the estate being administered in
bankruptcy”~-but that the Seventh Circuit has adopted a “slightly

different” test. See id. at 308-09 n.6.‘

3 Like Celotex, the instant case involves the second type of “related to”

proceeding.

4 The Supreme Court seemed to favor this test, but did not adopt any
particular test. 514 U.S. at 308-09 n.6.


Minute Order Form (06/97)

7 \Y United States District Court, Northern District of Illinois

Name &f igned Judge 7 Sitting Judge if Other
get Judge ; John F. Grady thar Assigned Judge
CASE NUMBER 03 C 263 DATE May 23, 2003
CASE Megliola, et al v. Andrew J. Maxwell
TITLE

[in the following box (2) indicate the party filing the motion, ¢.g., plaintiff, defendant, 3rd party plaintiff, and (b) state briefly the

nature of the motion being presented.)

qt)

v. Bernard, 00 C 6676, is affirmed. ENTER MEMORANDUM OPINION.

x (For further detail see order (on reverse side of/attached to) the original minute order.]

MOTION:

DOCKET ENTRY:

(1) 0 Filed motion of [ use listing in “Motion” .box above.]

(2) Brief in support of motion due

(3) o Answer brief to motion due___._ Reply to answer brief due___

(4) Qo Ruling/Hearing on__setfor____att

(5) a Status hearing[held/continued to] [set for/re-set for]on__——sset for__—_at

(6) o Pretrial conference[held/continued to} [set for/re-set for]on__——ssetfor_— at

(7) a Trial[set for/re-set for]on ss at_

(8) Oo [Bench/Jury trial] [Hearing] held/continued to at.

(9) a This case is dismissed [with/without] prejudice and without costs[by/agreement/pursuant to]
OO FRCP4(m) O General Rule21 © FRCP41(a)(1) © FRCP41(a)(2).

a0) «of [Other docket entry] The bankruptcy court’s order which preliminarily enjoined the prosecution of Sutton

No notices required, advised in open court.

No notices required.

Document
Number

numberof
x. | Notices MAILED by judge’s staff. yn
Notified counsel by telephone. ve docketed
Docketing to mail notices
K | Mait 40 450 form. Laced Ay nr
Copyto.
date dea ice
courtroom £
KAM deputy’s KAM
initials Date/time received in
cebledl Cletles Office: | C13 mating deputy intas

(Reserved for use by the Court)



-11-

We agree with the bankruptcy court’s reading of Fisher, and
appellants’ attempt to distinguish the case fails.° Appellants
argue that the plaintiffs in Fisher “were estate creditors and for
this reason alone were required to ‘wait their turn behind the
trustee.’” (Appellants’ Brief at 12.) We believe that this is an
incorrect characterization of Fisher (the plaintiffs’ status as
creditors was not the single dispositive factor), and we do not
find the factual distinction meaningful in any event. The general
principles of “related to” jurisdiction of both Celotex and Fisher
still apply. The relevant inquiry is not whether the Class Action
plaintiffs are creditors of the estate. See Xonics, 813 F.2d at
131 (“{I]t is the relation of dispute to estate, and not of party
to estate, that establishes jurisdiction.”) Rather, it is whether
the Class Action affects the bankruptcy estate or the allocation of
property among creditors. The bankruptcy court found that the
Class Action affects the bankruptcy estate, due to the insurance

situation, and accordingly preliminarily enjoined the Class Action.

8 Bppellants rely on In re Reliance Acceptance Group, Inc., 235 B.R. 548
(D. Del. 1999), to support their argument that the factual distinction is
meaningful. Like appellants, though, Reliance fails to explain why a plaintiff's
status of shareholder rather than creditor makes a difference in the “related to”
analysis. Moreover, Reliance does not discuss the general principles of “related
to” jurisdiction. We agree with the bankruptcy court that Reliance is neither
controlling nor persuasive.



- 10 -

the Bankruptcy Court concluded, inter alia, “that the
trustee had satisfied the requirements for an injunction
under § 105, finding that both parties were pursuing the
same dollars from the same defendants to redress the same
harms . . .” 155 F.3d at 880. The District Court to
which the judgment was appealed dissolved the injunction.
The Seventh Circuit then heard the case and issued the
opinion which is of critical importance to the matter
before this court.

In the opinion, the Seventh Circuit reversed the
District Court and reinstated the injunction. The
problem to be resolved, as the Court viewed it, was that
the investors were not suing the debtors, but “third
parties who are not in bankruptcy, and who allegedly
committed various acts of fraud against them - nondebtor
tortfeasors . ” Fisher v. Apostolou, 155 F.3d at 879.
The Court found that “the investors’ claims [were]
sufficiently related to the property of the estate that
their pursuit should be stayed pursuant to § 105 until
the bankruptcy court has disposed of the trustee’s claims
based on the same underlying transactions.” 155 F.3d at
878.

Maxwell, 288 B.R. at 530-31.

The bankruptcy court recognized that there is a difference
between Fisher and this case because there, the district court case
was brought by defrauded investors, while here, the district court
case has been brought by allegedly defrauded shareholders. The
bankruptcy court, however, did not think the distinction was
dispositive and applied Fisher, stating that “this Court reads the
Fisher decision as standing for the proposition that a trustee may
temporarily block adjudication of claims that are not property of
the estate by petitioning the bankruptcy court to enjoin other
litigation if it is sufficiently ‘related to’ his own work on

behalf of the estate.” Maxwell, 288 B.R. at 532.



-7-
the Class Action is ‘related to’ an adversary proceeding filed by

the Trustee. ”?

(Appellants’ Brief at 1.)

Appellants contend that the Seventh Circuit’s ruling in Fisher
v. Apostolou, 155 F.3d 876 (7th Cir. 1998), upon which the
bankruptcy court relied in part, is limited to cases in which the
plaintiffs whose action is sought to be enjoined are creditors of
the estate who would benefit from the trustee’s action. Because
they are not creditors of the Marchfirst estate and would not
benefit from proceeds obtained for the estate by the Trustee,
appellants argue, Fisher does not apply in this case to allow the
injunction of their Class Action.

Appellee, the Trustee, asserts that Fisher applies because
there is no reason to treat shareholders’ claims that are “related
to” a bankruptcy differently from creditors’ claims that are
related. The Trustee further contends that, in evaluating whether
a third-party proceeding is “related to” a bankruptcy, courts focus
on the impact of that third-party action on the bankruptcy estate,
not on the interests of the third party asserting the claim sought
to be enjoined.

In order for a bankruptcy court to have jurisdiction to enjoin

a proceeding (such as the Class Action), the proceeding must arise

under, arise in, or be related to a bankruptcy case. See Celotex

# Section 105{a) of the Bankruptcy Code provides in pertinent part that
the “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).



-3-
policy (the “Primary Policy”) from Illinois National Insurance
Company (“Illinois National”). The Primary Policy covers (1)
losses sustained by Marchfirst’s directors and officers while
acting in those capacities; and (2) losses sustained by Marchfirst
arising from any securities fraud claim brought against it or from
amounts paid to indemnify the officers and directors for claims
brought against them. The limit of liability under the Primary
Policy is $25 million.

Marchfirst had also bought two excess directors’ and officers’
liability policies (the “Excess Policies”) from North American
Specialty Insurance Company (“North American”) and Federal
Insurance Company (“Federal”), which provided excess coverage of
$15 million and $10 million, respectively. The terms of the Excess
Policies mirror the terms of the Primary Policy.

Both the Class Action plaintiffs and the Trustee seek to
satisfy potential judgments in their actions from the assets of
Marchfirst’s former directors and officers and from the proceeds of
the insurance policies. The insurers, however, are contesting
coverage. Illinois National asserts an “insured vs. insured”
exclusion to coverage. North American and Federal assert the same
exclusions and also take the position that a “claim” by the

insureds was not made during the policy period.



-2-
consulting corporation.’ The complaint, which was filed in October
2000, alleges that defendants misled the investing public and
thereby artificially inflated the price of Marchfirst’s stock by
publicly issuing materially false and misleading statements and
failing to disclose material facts necessary to make those
statements not false and misleading.

The Bankruptcy and the Trustee Action

In April 2001, Marchfirst filed a voluntary petition for
reorganization, pursuant to Chapter 11 of the United States
Bankruptcy Code, in the United States Bankruptcy Court for the
District of Delaware. The case was soon converted to a Chapter 7
bankruptcy, and in July 2001, it was transferred to the United
States Bankruptcy Court for the Northern District of Illinois.
Andrew J. Maxwell was appointed Trustee of Marchfirst’s estate. In
February 2002, the Trustee filed an action (the “Trustee Action”)
against eleven former directors and officers of Marchfirst,
including all three of the Class Action defendants. The Trustee
alleges that the former directors and officers breached their
fiduciary duties to Marchfirst.

The Insurance Policies
Prior to the filing of the bankruptcy case, Marchfirst had

purchased a directors’ and officers’ corporate liability insurance

V Marchfirst itself was named as a defendant in the original complaint,
but not in the amended complaint filed in May 2002. The three defendants in the
Class Action are Robert Bernard, Robert Clarkson, and Bert Young.



03-263.031-JcD May 23, 2003

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION

ayevEr
DOCKETER
LEONARD MEGLIOLA, JR. and MAY 27 2003
JON LOGAN NELSON, on behalf of
themselves and all others
Similarly situated,

Appellants,

v.
No. 03 C 263
ANDREW J. MAXWELL, Chapter 7
Trustee for the bankruptcy
estate of Debtors,

Appellee.

MEMORANDUM OPINION
This is an appeal from an order of the bankruptcy court that
preliminarily enjoined prosecution of the district court action

captioned Sutton et al. v. Bernard et al. For the reasons

explained below, the order of the bankruptcy court is affirmed.
BACKGROUND
The Class Action
Sutton v. Bernard, No. 00 C 6676 (the “Class Action”), is a
class action lawsuit pending before this court in which the
shareholder plaintiffs allege securities fraud against three

officers of Marchfirst, Inc. (“Marchfirst”), a Chicago-based



-~ 12 -
We believe that the bankruptcy court’s findings and analysis
regarding this issue were correct.®
CONCLUSION
For the foregoing reasons, the bankruptcy court’s order, which

preliminarily enjoined the prosecution of Sutton v. Bernard, 00 C

6676, is affirmed.

DATE: May 23, 2003
ENTER: APL
John Ff Gfady, United States Distri ge

8 Because we affirm the issuance of the preliminary injunction on this
basis, it is unnecessary to reach the Trustee’s argument (with which the
intervenors’ briefs are concerned) that the injunction could be affirmed on the
basis that the insurance proceeds are property of the debtor’s estate. (The
bankruptcy court held that the proceeds do not belong to the estate.)