In re Windstream Holdings, Inc.

Finding that in a corporate bankruptcy case a person or entity can be held in civil contempt for an automatic stay violation when “there is no fair ground of doubt” that its conduct violated the stay, the Second Circuit Court of Appeals held that false and misleading advertising focused against the debtor by a competitor was not an exercise of control over estate property and therefore not a stay violation.  In re Windstream Holdings, Inc., 2024 WL 3195997 (2d Cir. June 24, 2024).  Click here for the full decision: https://1.next.westlaw.com/Document/I720a95c034c611ef9bc1a058ad8d82e2/View/FullText.html?originationContext=typeAhead&transitionType=Default&contextData=(sc.Default)

Facts:

Windstream Holdings, Inc. (the “Debtor”) is a diverse telecommunications entity that provides cable TV, VoIP telephone, and broadband services, among others.  In February 2019, the Debtor filed for bankruptcy under Chapter 11, triggering the automatic stay protections afforded by 11 U.S.C. section 362(a).[1]  According to the Debtor, within a week of the petition date it secured one billion dollars in debtor-in-possession financing allowing it to continue its business operations.

In March 2019, Charter Communications, Inc. and Charter Communications Operating, LLC (collectively, “Charter”), competitors of the Debtor, commenced a direct-mail campaign targeting the Debtor’s customers.  The mailings misrepresented the sender’s identity, suggested that the Debtor may cease operating or offer unreliable services as a result of the bankruptcy, and encouraged Debtor’s customers to switch to Spectrum, Charter’s internet brand.  The mailings noted that the Debtor required customers to sign two-year contracts, offered to buy customers out of their contracts, and promised that Spectrum would not require long-term obligations.

Charter sent the mailings to about 800,000 residences in geographic markets deemed to have high concentrations of Debtor’s customers, based on publicly available information.  According to the Debtor, it lost approximately 1,386 customers and spent over $860,000 in credits, discounts, and other promotions designed to discourage customer defections.

In April 2019, the Debtor filed an adversary action against Charter alleging, among other claims, that the direct-mail campaign amounted to an exercise of control over the Debtor’s property by harming its goodwill and encroaching on Debtor’s customer contracts.  At the Debtor’s request, the bankruptcy court issued a temporary restraining order and, ultimately, a preliminary injunction requiring Charter to stop its advertising campaign.

The bankruptcy court subsequently granted Debtor’s summary judgment motion, finding, among other things, that Charter violated the automatic stay.  According to the court, the violation entailed Charter’s dissemination of false and misleading advertising, “in an effort to control” estate property, e.g., Debtor’s “customers or contracts with those customers.”  The court reserved its decision on damages, concluding that there was a question as to whether Charter’s actions met the test for civil contempt.

After a four-day trial, the bankruptcy court held Charter in civil contempt.  It found that Charter’s improper advertising campaign “wrongfully interfered with [Debtor’s] customer contracts and goodwill.”  It sanctioned Charter $19,179,329.45 to compensate the Debtor for the losses it suffered as a result of Charter’s wrongful actions.

Charter appealed to the United States District Court, which reversed the lower court’s ruling.  The district court disagreed that the direct-mail campaign amounted to “an act to exercise control” over the Debtor’s property or that civil contempt was appropriate.  It also concluded that the bankruptcy court exceeded its discretion by issuing the contempt order under Section 105(a), because there was a “fair ground of doubt” as to whether Charter’s actions in fact violated the automatic stay.

The Debtor appealed to the Second Circuit Court of Appeals, which affirmed the district court’s ruling.

Reasoning:

The Court of Appeals confirmed that, in corporate bankruptcy cases, a bankruptcy court’s ability to punish willful violators of the automatic stay is derived under the broad administrative powers in Section 105(a).  That is because Section 362(k) sanctions apply only in cases where the debtors are natural persons.

The Court then cited to Taggart v. Lorenzen, 587 U.S. 554, 557 (2019), which established the test for determining whether a violator of a debtor’s post discharge injunction should be held in civil contempt under Section 105(a).  According to Taggart, such a violator may be held in contempt “if there is no fair ground of doubt as to whether the order barred the [party’s] conduct.”  (Emphasis original.)  To find that “no fair ground” of doubt exists, a court must determine that “there is no objectively reasonable basis for concluding that the [party’s] conduct might be lawful under the discharge order.”

Though the Supreme Court distinguished between Section 362(k) automatic stay violations and remedies under Section 105(a), the Windstream court concluded that the distinction is without a difference where entities are subject to stay violation sanctions under Section 105(a).  Being that under either discharge injunctions or stay violations basic principles of fairness require that those being enjoined “receive explicit notice of what conduct is outlawed before being held in civil contempt,” the Court concluded that there is no reason the Taggart test could not be applied to Section 105(a) stay violation contempt actions.

With the applicable test decided, the Court went on to consider whether there was “no fair ground of doubt” to determine that civil contempt sanctions were appropriate in this case.  According to the Debtor, there was no ground of doubt that Charter violated the automatic stay when it exercised control over Debtor’s customer contracts and goodwill.  Charter disagreed, arguing that neither the contracts nor Debtor’s goodwill were estate property.  Even if they were, Charter asserted that its direct-mail campaign did not amount to the exercise of control over such assets as to violate the automatic stay.

The Court of Appeals examined the characteristics of a debtor’s contract rights and goodwill and concluded that both are property of the estate under Section 541(a)(1).  However, this was not the end of the analysis.  The Court next asked whether Charter exercised control over these assets within the meaning of Section 362(a)(3).

The Supreme Court has held that obtaining possession of property means taking something from or exercising “dominion over” such an asset.  Citizens Bank of Md. v. Strumpf, 516 U.S. 16, 21 (1995).  A “typical definition of ‘control’ is: ‘To exercise authority over; direct; command.’ ”  In re Weber, 719 F.3d 72, 79 (2d Cir. 2013).

The Court of Appeals agreed with the district court that the types of acts held as exercises of control traditionally involved litigation or legal actions that directly or indirectly destroyed or transferred control of a debtor’s property.  However, it noted that conduct “that affects consumer behavior” is not the type of conduct previously prohibited by Section 362(a)(3).

Here, the Court found, the Code does not prohibit Charter from “informing the public about” the Debtor’s insolvency or from telling the public that the Debtor may be unable to service its customers.  The Code also does not prohibit competitors from letting a debtor’s customers know about their legal rights in dealings with the debtor.

While the automatic stay prohibits actions that interfere with administration of bankruptcy estates, the Court referred to multiple cases holding that merely because an action was “factually likely” to interfere with such administration was not sufficient.  The Debtor had to prove that Charter’s offending actions were “legally certain” to interfere with the Debtor’s customer contracts and goodwill.

The Court distinguished a case cited by the Debtor in which the defendant had access to the debtor’s customer list and used it to misinform customers that the debtor was closing its business and leading them to believe that the competitor had been authorized to assume the accounts.  In that case, the offending party sent representatives to customer homes to ensure that they switched their accounts.

Here, there was no evidence that Charter used any of the Debtor’s proprietary information or that it assumed the Debtor’s customer accounts.  The Court expressed a concern that the automatic stay was designed to give a debtor a “fresh start” not a “head start.”  It therefore refused to construe the term “exercise of control” to mean actions that could ultimately hurt customer choices or a competitor’s rights to advertise or compete against the debtor during a bankruptcy case, which could have an “unimaginable result.”

In reaching a different conclusion than the district and appellate courts, the bankruptcy court stated,

No reasonable person would believe that [Charter’s] advertising campaign, designed to use false and knowingly misleading information to cause the [Debtor’s] customers to terminate their contracts and switch to Charter, protected a legitimate interest of Charter’s and did not harm property interests of the Debtors. Although every corporation expects legitimate advertising by competitors, and thus such advertising does not “exercise control” over its property, improper advertising such as [Charter’s] clearly and objectively interfered with the [Debtor’s] customer contracts and goodwill and thus clearly was precluded by section 362(a)(3)’s plain terms and the caselaw applying them.

In re Windstream Holdings, Inc., 627 B.R. 32, 47 (Bankr. S.D.N.Y. 2021), vacated in part, 634 F. Supp. 3d 99 (S.D.N.Y. 2022), aff’d, No. 22-2891-BK, 2024 WL 3195997 (2d Cir. June 24, 2024), emphasis added.

The appellate court disagreed with the distinction expressed by the bankruptcy court between “legitimate” and “improper” advertising, noting that this distinction is not made by the Code and that the bankruptcy court cited no authority for the “dichotomy it drew.”

Concluding that because it is “skeptical” that Charter’s actions amounted to an exercise of control over Debtor’s property, “we hold that there is, at least, a ‘fair ground of doubt’ that Charter violated the automatic stay.”  The Court therefore could not find that the district court erred.

Author’s Comments:

While the appellate and bankruptcy courts appear to agree on the test used to determine whether Charter violated the automatic stay, the courts’ divergent conclusions illustrate the difficulty of determining when a competitor of a bankruptcy debtor has exercised control over estate assets.  Charter attempted to mislead the Debtor’s customers about the viability of the Debtor’s business and to convert the customers to Charter’s subsidiary.  Should these actions be held to violate the automatic stay?  Does it matter that Charter’s acts sought to destabilize the status quo ante that the Code seeks to protect?

As the district and appellate courts recognized, it is difficult to create a bright line rule as to what competitors may or may not do to compete with a debtor in bankruptcy.  While the bankruptcy process has an interest in protecting estate assets for the benefit of creditors, that protection should not interfere with the market dynamics in the debtor’s business sector.

While Charter’s apparently false advertising may be actionable under multiple legal theories, including the Lanham Act and state laws, the Court of Appeals was likely correct that the activities did not result in the exercise of control over the Debtor’s assets.  Stated another way, a bankruptcy filing should not disadvantage third party non-debtor entities which seek to compete and even take advantage of the bankrupt debtor’s weakened position.  As the Court suggested, an entity’s efforts to compete against a bankrupt debtor, even when they violate other laws, should not amount to stay violations unless they legally interfere with the debtor’s contract or other property rights, such as through contract breaches, lawsuits, or usurpation of specific property rights owned by the bankruptcy estate.

[The Commercial Finance Newsletter is written by an ad hoc group of the California Lawyers Association’s (CLA) Business Law Section.  These materials were written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, located in Los Angeles, California, who is a member of the ad hoc group and the immediate past representative from the Business Law Section (BLS) to the CLA’s Board of Representatives.  Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group.  The opinions expressed herein are solely those of the author.]

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[1] Unless stated otherwise, all statutory references are to the Bankruptcy Code (the “Code”), codified under 11 U.S.C. sections 101 et al.