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Bankruptcy Litigation – The Automatic Stay

Oct 19th, 2020

This blog first appeared as part of an article in Trial Talk, Oct/Nov 2017 – “What Every Trial Lawyer Should Know About Bankruptcy,”

While bankruptcy law is a very specialized practice, and the Bankruptcy Code an intricate and interwoven statute, good lawyers should have enough working knowledge to know what the filing of a bankruptcy case may mean in the context of their cases.

As many a trial lawyer has discovered through painful experience, a bankruptcy filing can wreak havoc on carefully planned litigation strategy. Even more painfully, they may have found out the hard way that a lack of understanding of the automatic stay, as detailed in Section 362 of the Bankruptcy Code, can lead to serious consequences.

What is Stayed?

Section 362(a) provides a laundry list of actions that are stayed upon the bankruptcy filing.  As concerns litigation and collection efforts, these statutory provisions and the italicized language are particularly relevant:

Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303  . . . operates as a stay, applicable to all entities, of—

(1)  the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;

. . .

(3)  any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;

. . .

(6)  any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title; . . .[1]

The broad language of subsections 362(a)(1), (3), and (6) should cause every litigator to think twice before taking any action in a case in which a party has filed bankruptcy.  Section 362(a)(1) very clearly prohibits the “commencement or continuation” of judicial and administrative proceedings against the debtor.  Thus, the automatic stay prevents the filing of a lawsuit against the debtor,[2] as well as the continued prosecution of a lawsuit against the debtor.[3]  Even if the debtor-defendant obtained a favorable ruling, the automatic stay prevents entry of a court order.[4]  Appeals from lawsuits in which the debtor was the defendant are also stayed – even if the debtor is the appellant.[5]

If the debtor is the plaintiff, the automatic stay does not prevent the debtor’s commencement or continued prosecution of the case.[6]  If the case involves a counterclaim against the debtor, however, the court may permit the debtor’s claim to proceed while staying the counterclaim.[7]

The stay prevents foreclosure threats,[8] postpetition entry of judgment,[9] issuance of a writ of execution,[10] and collection activities such as repossessions.[11]

In chapter 12 and 13 cases, the stay also protects non-debtor parties who are jointly liable with the debtor for payment of a consumer debt.[12]  For instance, if a husband and wife jointly sign a car loan, but only the husband later files a chapter 13 bankruptcy case, the lender may not proceed against the non-debtor spouse until the stay lifts by court order or operation of law.  Trial lawyers should be mindful of this expanded “automatic stay” applicable to non-debtors.

What is Not Stayed?

The answer to what actions are not stayed is found in section 362(a), the numerous exceptions to the stay listed in section 362(b), and a multitude of reported cases in which parties disagreed over the interpretation of these Bankruptcy Code sections.

Section 362(a)(1) stays legal proceedings against the debtor that were or could have been commenced before the filing of the bankruptcy case.  Therefore, as noted above, actions filed by the debtor are not stayed.  And actions that accrue after the bankruptcy filing are not subject to the automatic stay under section 362(a)(1).[13]   Similarly, by implication, section 362(a)(6) does not stay acts to collect on claims that arose after the bankruptcy filing.   Before acting, however, the careful litigator must ask:  will my actions violate some other provision of section 362(a) – such as 362(a)(3) – which prohibits actions to take possession or control of property of the estate or from the bankruptcy estate.  The careful litigator must review all of section 362 carefully and then proceed with caution.

Section 362(b) provides a long list of exceptions to the automatic stay, many of which apply to governmental entities.  For instance, the stay does not apply to criminal actions against the debtor, section 362(b)(1); the exercise of police powers, section 362(b)(4); and certain tax-related proceedings, such as audits, 362(b)(9).   Other notable exceptions apply to proceedings involving certain domestic issues, such as paternity, child custody, domestic support, and dissolution proceedings (except for division of property), 362(b)(2).

A common scenario in which trial lawyers may find themselves asking “does the stay apply here?” occurs when one of multiple defendants files bankruptcy before or during trial or appeal.  Does the existence of a debtor-defendant bring everything to a screeching halt?

The answer is usually “no.”  In Duffy v. Grogan Enerserv Corp., the trial court entered judgment against the four affiliated defendants despite the announcement that one of them had filed bankruptcy.  On appeal, the defendants argued that the judgment was void as to all of them. The appellate court reversed the judgment as to the debtor but affirmed the judgment against the three non-debtors, noting that “[t]here is nothing in [section 362(a)] which purports to stay claims against co-defendants of the debtor.” [14]   More recently, the U.S. District Court reaffirmed that principle, stating “[b]y its plain language, the statute applies the stay only to actions or proceedings ‘against the debtor.’  [11 U.S.C. § 362(a)] (emphasis added). Thus, the Tenth Circuit recognizes that, as a general rule, ‘the stay provision does not extend to solvent codefendants of the debtor.’”[15]

Can the Stay Protect Non-Debtor Codefendants?

While the stay is “automatic” as to debtors, non-debtors may petition the bankruptcy court to expand the stay’s protective reach to them if pursuit of claims against the non-debtors would imperil the debtor in some significant way.  One of the most notable exercises of the bankruptcy court’s powers to extend the stay occurred in the A.H. Robins bankruptcy case, filed in response to more than 5,000 lawsuits concerning the company’s contraceptive device.    Extending the automatic stay to A.H. Robins’ co-defendants (its directors and officers who were entitled to indemnification from the company), the Fourth Circuit Court of Appeals concluded that “unusual circumstances” existed to warrant the extension.[16]  The A.H. Robins court relied on section 362 and the court’s equitable powers to conclude that expansion of the stay was needed because the continued litigation threatened property of the bankruptcy estate, burdened and impeded the company’s reorganization efforts, contravened the public policy inherent in the Bankruptcy Code, and rendered any plan of reorganization futile.[17]

Needless to say, a case like A.H. Robins does not come along every day.  Still, the principles behind the court’s expansion of the automatic stay apply in analyzing situations involving expansion of the stay to non-debtors.  The Tenth Circuit Court of Appeals relied on A.H. Robins to affirm the denial of stay protection to a co-defendant whose company filed bankruptcy, finding that the owner did not present “unusual circumstances” to create an exception to the general rule that the stay protects only debtors.[18]  Because the plaintiff’s claim against the owner was separate and apart from the stayed claim against the company, the court concluded that no basis existed to extend the stay.[19]   Similarly, a court refused to extend the stay to the non-debtor co-defendants not only because they had failed to establish “unusual circumstances,” but also because they had not first asked the bankruptcy court to expand the stay.[20]

When does the Stay End?

The automatic stay can end by court order or by operation of law.  Creditors who want to start or continue with litigation against the debtor should seek relief from the stay by filing a motion with the bankruptcy court.  One should also consider whether waiting for the stay to lift by operation of law may work just as well.

Seeking Relief from Stay

Section 362(d) spells out two paths to an order granting relief from the stay:  (i) proof of “cause” or (ii) in the case of a stay against property, proof that the debtor lacks equity in the property and that the property is not necessary to an effective reorganization.  Lifting the stay for “cause” is typically the most applicable basis for seeking relief from the stay to commence or continue a lawsuit. The party opposing relief from the stay for “cause” (usually the debtor or trustee) has the burden of proof.[21]  An assessment of “cause” is necessarily very fact-intensive, but Colorado bankruptcy courts review a list of “Curtis factors”[22] to decide whether to lift the stay.  The list is not exhaustive, and not every factor fits every case, but the factors provide a guideline for the bankruptcy court’s exercise of discretion.[23]  Among the more commonly considered factors are: (i) whether the relief will result in partial or complete resolution of the issues, (ii) the lack of any connection with or interference with the bankruptcy case, (iii) whether the other forum is a specialized tribunal with expertise to hear the case, (iv) whether the debtor’s insurance carrier has assumed full financial responsibility for defending the litigation, (v) the interest of judicial economy and the expeditious and economical resolution of the litigation, and (vi) whether the parties are prepared for trial.  Another factor endorsed by the Tenth Circuit as possibly “dispositive” is the movant’s chances of success in the litigation.[24]

When has “cause” existed to lift the stay for new or continuing litigation?  Here are some examples:

  • Stay lifted to permit former employer to seek injunctive relief only, and not damages, against chapter 7 debtor to enforce non-solicitation and confidentiality provisions of employment contract[25];
  • Stay lifted to permit former employer to litigate claims for employee’s alleged fraud, civil theft, and breach of fiduciary duty where (i) resolution of state court litigation may result in fact findings significant to creditors’ action to prevent dischargeability of debt, which creditors intended to commence, and (ii) state court case was on verge of trial[26];
  • Stay lifted to permit creditors to prosecute claims against chapter 13 debtor for unjust enrichment, aiding and abetting husband’s fraud; although litigation would likely not result in findings relevant to non-dischargeability issues, it would liquidate claims that would require liquidation for debtor’s chapter 13 plan, and case was ready for trial[27];
  • Stay lifted so that creditor could continue state court action alleging debtor’s legal malpractice to prevent “redundant litigation” for creditor in state and bankruptcy courts and in light of creditor’s agreement to limit recovery to insurance proceeds and assets of co-defendant law firm[28];
  • Stay lifted to permit continuation of arbitration proceeding that was largely completed when concluding the arbitration would liquidate creditor’s claim and be less expensive and more expeditious for various reasons, including limited appellate rights[29];
  • Stay annulled retroactively to validate and complete eviction proceedings against debtor, who did not notify creditor of bankruptcy filing.[30]

Termination of Stay by Operation of Law

The automatic stay automatically ends, by operation of law, upon a number of events that occur in almost every bankruptcy case:  (i) when the case is closed or dismissed, or (ii) for individual chapter 7 debtors or cases under chapters 9, 11, 12 or 13, when a discharge is granted or denied.[31]  The stay of an act against property of the estate ends when the property is no longer property of the bankruptcy estate.[32]  The Bankruptcy Code also provides for termination of the stay by operation of law in special circumstances, such as repeat bankruptcy filings.[33]

Stay Violations are Void, and Violators are Subject to Damages and Sanctions

Because the automatic stay is so broad in scope, and exceptions to it are narrowly construed, the prudent lawyer will not proceed in the face of ambiguity about whether the stay applies.  “The determination of whether the automatic stay applies to any given activity or property is to be made in the first instance by the bankruptcy court, not by a creditor or its attorney.”[34]  So, when in doubt about the applicability of the stay, ask the bankruptcy court.  As one Colorado bankruptcy judge warned, “A creditor and its agents act at their own peril when they usurp the bankruptcy court’s role in determining the scope of the automatic stay, without binding authority that is clearly applicable to the facts at hand. Filing a stay relief motion is an inexpensive form of insurance against a stay violation award.”[35]

Actions taken in violation of the stay are void, even without the plaintiff’s knowledge of the stay.[36]  Thus, as noted, the postpetition filing of a lawsuit against the debtor is void.  So are the issuance of a Public Trustee’s deed during the redemption period and a notice to evict and an eviction occurring after the bankruptcy filing.[37]

Creditors who knowingly act with knowledge of the automatic stay can suffer greater consequences than simply learning that their actions are “void.”   Bankruptcy Code section 362(k)(1) provides that “an individual injured by any willful violation of a stay . . . shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.”  Once the bankruptcy court has found that the creditor willfully violated the stay, the imposition of a damage award is mandatory.[38]

What does it mean to “willfully” violate the stay?  That the creditor intentionally violated the stay?  No!   A creditor “willfully” violates the automatic stay when it (i) knows that the automatic stay is in effect and (ii) intends the actions that constitute the stay violation.[39]   Proof of specific intent to violate the stay is not necessary for a finding of “willfulness.”[40]

Some conduct is clearly willful, warranting severe sanctions.  A creditor who repossesses a car without knowledge of the bankruptcy filing, but refuses to return the car after learning of the automatic stay, is a classic example.[41]  Cautionary tales involving “gray areas” abound in the world of automatic stay violations and provide support for filing a motion to lift the stay when in doubt.

One such tale involves a domestic relations hearing in which the petitioner/ex-wife sought relief (including a finding of contempt) for her ex-husband’s failure to comply with the court’s order requiring maintenance and child support payments.[42]  Although the ex-husband filed his bankruptcy case the day before the scheduled contempt hearing, as well as a motion to vacate the contempt hearing in light of the automatic stay, the ex-wife convinced the court to proceed on the bases that (i) the contempt proceeding was excepted from the automatic stay under section 362(b)(1) as a “criminal proceeding” and (ii) an exception existed because the ex-wife sought only a modification of an order for domestic support obligations.[43]  The family court judge entered an order prohibiting the ex-husband from disposing of any of his non-bankruptcy-estate property and requiring him to pay costs for the witnesses who appeared at the hearing.   Afterwards, the debtor filed an adversary proceeding against his ex-wife and her lawyer seeking an award of damages under section 362(k) for their willful violation of the stay.  Stating that a good-faith belief that a creditor has a right to property is irrelevant to a determination of “willfulness,”[44] the bankruptcy court found that the ex-wife and lawyer willfully violated the stay, that the debtor suffered actual damages as a result, and that a separate hearing was necessary to determine whether and to what extent punitive damages were appropriate.[45]

The Final Point

In the Tenth Circuit, “[w]illfulness is to be liberally construed to bolster the protections of the automatic stay, and is designed to ensure compliance with the stay by encouraging creditors to seek relief from the court whenever they are on notice of even a potential stay violation.”[46]  The point:  bankruptcy court is not the place to act first and seek forgiveness later.

If a bankruptcy filing has disrupted your case and you are not sure what options remain open to you and your client, familiarize yourself with the basics of the Bankruptcy Code. Consider whether a call to an experienced bankruptcy lawyer is in your best interests in properly advising your client and protecting their interests. Next steps are not always obvious, but these would be steps in the right direction.

[1]   11 U.S.C. § 362(a).  Note, as discussed herein, that Bankruptcy Code sections 1201 and 1301 also create an automatic stay of certain actions against non-debtor parties who are jointly liable with the debtor on consumer debts.

[2]   In re Gagliardi, 290 B.R. 808, 815 (Bankr. D. Colo. 2003).

[3]   Gazzo v. Ruff (In re Gazzo), 505 B.R. 28, 44 (Bankr. D. Colo. 2014).

[4]   Ellis v. Consolidated Diesel Electric Corp., 894 F.2d 371, 373 (10th Cir. 1990).

[5]   Ace Tile Co., Inc. v. Casson Constr. Co., 715 P.2d 344, 346 (Colo. App. 1986); Baack v. Horizon Womens Care Prof’l, LLC (In re Horizon Womens Care Prof’l LLC), 506 B.R. 553, 556 (Bankr. D. Colo. 2014).

[6]   Riviera Drilling & Explor’n Co. v. Gunnison Energy Corp., 412 Fed. Appx. 89, 95 (10th Cir. 2011).

[7]   See, e.g., Vasile v. Dean Witter Reynolds, Inc., 20 F. Supp.2d 465, 502 (E.D.N.Y. 1998) (staying counterclaim); Koolik v. Markowitz, 40 F.3d 567, 568-69 (2d Cir. 1994) (staying appeal of prepetition lawsuit commenced by debtor in which defendant prevailed on counterclaim).

[8]   In re Ogden, No. 11-19841, 2015 WL 12817664, *4 (Bankr. D. Colo. June 1, 2015).

[9]   Cramer v. Grover (In re Cramer), 7 B.R. 133, 134-35 (Bankr. D. Colo. 1980).

[10]   In re Baird, 55 B.R. 316, 218 (Bankr. W.D. Ky. 1985).

[11]   Stellato v. Den-Cut Fin’l, LLC (In re Stellato), No. 12-01207, 2014 WL 1883978, *5 (May 9, 2014).

[12]   See 11 U.S.C. §§ 1201(a), 1301(a).

[13]   Garret v. Cook, 652 F.2d 1249, 1255 (10th Cir. 2011).

[14]   Duffy v. Grogan Enerserv Corp., 708 P.2d 809, 811 (Colo. App. 1985).

[15]   Global Logistics Solutions, LLC v. Ciao Group, Inc., 14-cv-2928, 2016 WL 1586425, *3 (D. Colo. Apr. 20, 2016), citing several cases.

[16]   A.H. Robins Co., Inc. v. Piccinin, 788 F.2d 994, 999 (4th Cir. 1986), cert. denied, 463 U.S. 1247 (1986).

[17]   Id. at 997.

[18]   Oklahoma Federated Gold & Numismatics, Inc. v. Blodgett, 24 F.3d 136, 142 (10th Cir. 1994).

[19]   Id.

[20]   Global Logistics, 2016 WL 1586425 at *4.

[21]   11 U.S.C. § 362(g)(2).

[22]   The “Curtis factors” were enumerated in In re Curtis, 40 B.R. 795 (Bankr. D. Utah 1984).

[23]   In re Hruby, 512 B.R. 262, 269 (Bankr. D. Colo. 2014).

[24]   Chizzali v. Gindi (In re Gindi), 642 F.3d 865, 872 (10th Cir. 2011), overruled on other grounds, TW Telecom Holdings, Inc. v. Carolina Internet Ltd., 661 F.3d 495, 497 (10th Cir. 2011).

[25]   Hruby, 512 B.R. at 274.

[26]   In re Dampier, 523 B.R. 253, 256-57 (Bankr. D. Colo. 2015), aff’d, BAP No. CO-15-006, 2015 WL 6756446 (10th Cir. BAP Nov. 5, 2015) (unpublished).

[27]   Id. at 257.

[28]   Peterson v. Cundy (In re Peterson), 116 B.R. 247, 250-51 (D. Colo. 1990).

[29]   Santangelo Law Offices, P.C. v. Touchstone Health LLC (In re Touchstone Home Health LLC), No. 17-11134, 2017 WL 3669541, * 19 (Bankr. D. Colo. Aug. 21, 2017).

[30]   In re Dennen, 539 B.R. 182, 187-88 (Bankr. D. Colo. 2015).

[31]   11 U.S.C. § 362(c)(2).

[32]   11 U.S.C. § 362(c)(1).  Note, however, that the property may still be “property of the debtor” and therefore subject to section 362(a)(5).

[33]   See, e.g., 11 U.S.C. § 362(c)(3).

[34]   Gagliardi, 290 B.R. at 814.

[35]   Id. at 818.

[36]   In re Calder, 907 F.2d 953, 956 (10th Cir. 1990); Gagliardi, 290 B.R. at 815.

[37]   Gagliardi, 290 B.R. at 815.

[38]   Gagliardi, 290 B.R. at 819.

[39]   Johnson v. Smith (In re Johnson), 501 F.3d 1163, 1172 (10th Cir. 2007).

[40]   Id.

[41]   In re Hollman, 92 B.R. 764, 768 (Bankr. S.D. Ohio 1988).

[42]   Gazzo, 505 B.R. 28.

[43]   See 11 U.S.C. § 362(b)(1) and 362(b)(2)(A)(ii).

[44]   Gazzo, 505 B.R. at 45, citing Gagliardi, supra, pp. 818-19, n. 29.

[45]   Id. at 46.

[46]   Johnson, 501 F.3d at 1173.