Restructuring

Contributed by Kyle J. Ortiz

“That ain’t right. Baby, that ain’t right at all.”

– Nat King Cole

Every now and then, an adversary makes an argument that you think just can’t possibly be right, but no authority exist to support what seems so obvious (presumably because nobody has been willing to litigate from such a position in the past). The debtor’s counsel in a recent case out of the United States Bankruptcy Court for the Northern District of Texas likely found himself in that exact situation when a creditor argued that the action it brought against the debtor had not violated the automatic stay. Though the bankruptcy case in which the creditor sued the debtor was not the debtor’s bankruptcy case, the creditor argued the action was nonetheless “kosher” under the Bankruptcy Code because the other case was pending before the same bankruptcy court. Come again?
Background
In In re Adkins, the debtor, Adkins, brought a motion against the creditor for willful violation of the automatic stay after the creditor filed a third-party action in an adversary proceeding in the separate chapter 7 case of a corporation that happened to be owned by Adkins called R.L. Adkins Corp. The creditor alleged that Corp. and Adkins should be treated as the same entity for purposes of the claims raised because Adkins allegedly dominated Corp. and used Corp. (and another company he owned) “as shams to perpetrate a fraud against” the creditor.
Shortly after the creditor brought the third-party action, Adkins’s attorney sent a letter to the creditor’s attorney stating that the third-party action against Adkins in Corp.’s bankruptcy case constituted a violation of the automatic stay and that Adkins should be dismissed from the creditor’s action against Corp. The creditor responded the same day calling Adkins’s attorney’s letter a spurious threat and stating that the automatic stay did not apply because “the suit was filed in the bankruptcy court in which Adkins is a debtor.” The same court, yes, but not the same case. This is where the debtor’s attorney probably found himself in that situation where he knew that wasn’t right but there wasn’t any case law on such a seemingly obvious proposition. In fact, the case law that existed in the Fifth Circuit appeared to support the creditor’s position.
After the creditor refused to dismiss the third party action against Adkins, Adkins brought his motion seeking damages for willful violation of the automatic stay. Under section 362(a)(1) of the Bankruptcy Code a stay is imposed that stays the commencement or continuation of any proceedings that could have been commenced against the debtor prepetition. Section 362(k)(1) of the Bankruptcy Code provides that “an individual injured by any willful violation of the stay … shall recover actual damages, including costs and attorney’s fees, and, in appropriate circumstances, may recover punitive damages.” The creditor contended that it had not violated the automatic stay because (i) although the third party action was brought in an adversary proceeding in a different bankruptcy proceeding, the other bankruptcy proceeding was related and was pending before the same bankruptcy court, and (ii) the third-party action was purely a “defense to a bankruptcy preference and fraudulent transfer action that was not and could not have been commenced before the filing of the debtor’s bankruptcy case,” and thus, the automatic stay did not apply.
Analysis
Addressing the latter argument first, the bankruptcy court stated that it did not agree with the creditor that its third-party action was not principally a prepetition cause of action and found the creditor’s argument that its action was merely a defense to preference and fraudulent transfer actions “difficult to follow” (i) because no preference claims were brought against the creditor in the adversary proceeding and (ii) because “it was brought as a third party action against [the debtor].” The court found that, as opposed to being a defense against the claims brought against the creditor, the third-party action was a separate veil piercing action and, thus, clearly related to prepetition claims. The court then turned to the argument that the automatic stay did not apply to the third-party action because the action was brought before the same bankruptcy court in which Adkins’s chapter 7 case was pending.
To support its argument, the creditor cited the Fifth Circuit’s decision in Campbell v. Countrywide Home Loans, Inc. in which the Fifth Circuit held “that an assertion in a proof of claim of increased payments to cover a prepetition claim” was not a violation of the automatic stay because the “automatic stay has no effect on actions that are expressly allowed under the Bankruptcy Code.” That seems plain enough, but the Fifth Circuit went on to state that: “The automatic stay serves to protect the bankruptcy estate from actions taken by creditors outside the bankruptcy court form and not legal action taken within the bankruptcy court.”
Although recognizing that a proof of claim and a third-party action are “significantly different,” the court noted that Campbell at least raised the issue of whether its holding could “be extended to a third-party action filed in an adversary pending in a different bankruptcy case, but before the same bankruptcy court.”
The court noted that Campbell relied in large part on a decision out of the Bankruptcy Court for the District of South Carolina, In re Sammon, in which the court held that the automatic stay “does not operate against the court with jurisdiction over the bankruptcy” and that the automatic stay “implicitly does not bar a party from commencing a proceeding against the debtor in the court where the bankruptcy petition is pending.” Relying on Sammon, the Adkins court went on to note that the third-party action technically met this judicially created exception to the automatic stay, observing that the creditor’s action in Adkins was a “proceeding against the debtor in the court where the bankruptcy petition is pending” and that it was a “‘legal action[] taken within the bankruptcy court’ that has jurisdiction over the debtor.” The court stated that, according to Sammon, actions such as the third-party action do not encroach on the purpose of the automatic stay.
The Adkins court, however, also must have felt that there was something intuitively wrong with the creditor’s argument. Consequently, it held that the exception in Sammon did not apply to the present case because such an exception “fails to account for the most basic purpose of the automatic stay not mentioned in Sammon: the breathing room afforded a debtor from his creditors upon a bankruptcy filing.”
The court went on to hold that the creditor willfully violated the automatic stay and emphasized that it was troubled by the creditor’s refusal to dismiss Adkins following his counsel’s letter. Thus, the court granted attorney’s fees and expenses.
Postscript
Before storing this case away in your file so that you have authority handy should you find yourself facing the same argument that confronted Adkins, be cautioned that although the court thought the creditor’s actions were a clear violation of the automatic stay, the court (reluctantly) granted certification of a direct appeal to the Fifth Circuit to determine whether “a third-party action filed against a debtor, but in an adversary proceeding that is pending in another bankruptcy case before the Court” is stayed by the automatic stay contained in section 362 of the Bankruptcy Code. The court observed that this was an issue that “technically . . . the Fifth Circuit has not addressed.” We will keep an eye on this case and see whether the Fifth Circuit thinks the creditor’s argument in Adkins were correct or says, “That ain’t right. Baby, that ain’t right at all.”