By George H. Singer
singerg@ballardspahr.com
The Court of Appeals for the Second Circuit recently established a “bright-line rule” in a case of first impression: If the debtor is named as a defendant in a prepetition lawsuit, the automatic stay operates to halt further proceedings. The court in Bayview Loan Servicing LLC v. Fogarty (In re Fogarty)1 issued a decision finding a willful violation of the automatic stay and emphasizing the expansive applicability of the automatic stay provisions of the Bankruptcy Code in a case where the debtor was named a defendant in underlying foreclosure proceedings even though the debtor’s interest in property was merely possessory.
The automatic stay is a legal provision that temporarily prevents creditors from trying to collect money or seize property from debtors in bankruptcy.2 It is self-effectuating in that it operates as an automatic injunction that, with certain exceptions, halts most civil lawsuits and collection activities involving the debtor and its property. A creditor that knowingly acts with knowledge of the bankruptcy case can suffer great consequences, because the Bankruptcy Code renders actions taken in violation of the automatic stay as void and permits the bankruptcy court to award actual damages, including costs and attorneys’ fees, as well as punitive damages for willful violations.3
The debtor in In re Fogarty resided in a home in Long Island, New York; however, title to the property was held by a limited liability company. There were significant delays in getting to a foreclosure sale. In fact, it took over eight years to obtain a foreclosure judgment in state court. The original foreclosure action omitted the debtor as a defendant. The debtor was later added during the course of the state court litigation and merely named as an “interested party.” After entry of the judgment in foreclosure and shortly before the scheduled foreclosure sale, the debtor filed a bankruptcy petition under Chapter 7 of the Bankruptcy Code. Servicer’s counsel, being advised by the debtor’s lawyer that the automatic stay precluded moving forward with the foreclosure sale, was of the view that since the real estate owned by the LLC was not property of the bankruptcy estate—a fact not in dispute—the sale was merely an in rem action and not subject to protection by the bankruptcy case of the individual debtor.
The Second Circuit found that the servicer violated the automatic stay even though the property was owned by a non-debtor LLC because the debtor was named as a defendant.4 The court rejected any distinction between in rem and in personam proceedings as the Bankruptcy Code does not require an inquiry as to why a debtor is named in legal proceedings. The fact that debtor was not personally liable did not matter. The appellate court also rejected the servicer’s argument that moving forward with the foreclosure sale of real estate in which the debtor had no legal interest was a mere ministerial act. To the contrary, foreclosure affects ownership and possessory interests and requires the exercise of judicial discretion. The debtor had a “possessory” interest as a tenant that constituted part of the bankruptcy estate.5 Since the appellate court found that the servicer willfully violated the automatic stay, the debtor was entitled to recover sanctions from the creditor as provided for by the applicable statute.
The case is a reminder that courts generally take an expansive view with respect to the restrictions imposed by the Bankruptcy Code’s automatic stay provisions, particularly where the debtor’s primary residence is implicated. As discovered by the servicer in In re Fogarty through painful experience, a bankruptcy filing can wreak havoc on carefully planned litigation, foreclosure, and collection strategies. A lack of understanding or insufficient attention to the implications of bankruptcy on various courses of action can have serious consequences. Servicers and other creditors should take careful note of the Second Circuit’s bright-line rule regarding the automatic stay and seek stay relief from the bankruptcy court in cases that implicate any interest (possessory or otherwise) in property to avoid potentially costly issues.6
GEORGE SINGER is a partner in the Minneapolis office of Ballard Spahr LLP and concentrates his practice on corporate and commercial law. Mr. Singer is a fellow of the American College of Bankruptcy and formerly served as an attorney on staff with the National Bankruptcy Review Commission.
Notes
1 39 F.4th 62 (2d Cir. 7/6/2022).
2 11 U.S.C. §362.
3 Id. §362(k).
4 Id. §362(a)(1) and (a)(2) (staying the commencement or continuation of proceedings against the debtor as well as the enforcement against the debtor of a judgment).
5 It did not appear to matter to the court that there was apparently no lease between the debtor and the LLC that owned the property entitling the debtor to legal possession and that the debtor was not paying rent.
6 Id. §362(d) (permitting a creditor to obtain relief from the automatic stay for “cause” and other grounds set forth in the statute).