LEAVES OF AUTOMATIC STAY

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1 LEAVES OF AUTOMATIC STAY A s an English major in college, my first reaction to seeing the title of this manuscript was to note that it does not contain a passing reference to Walt Whitman's famous poem Leaves of Grass. Unlike Whitman's Leaves of Grass published in 1855 and enjoyed by millions of readers, Leaves of Automatic Stay are enjoyed only by creditors who seek permission from the bankruptcy court to deal with defaulting debtors. Most nonbankruptcy attorneys who attempt to read through Section 362 of the Bankruptcy Code find their brains horribly addled after just 5 minutes of reading. Section 362 of the Bankruptcy Code is lengthy and complex and gives creditor attorneys fits and starts. This manuscript attempts to shed light on one area of 362's automatic stay -- when may the automatic stay be lifted to allow a state or federal court lawsuit to proceed against a debtor itself and not against property of the estate. The basic premise of the automatic stay is that the filing of bankruptcy causes a stay of all collection efforts to be entered "automatically" with the filing of the petition. Debtors need no additional motions or orders from the bankruptcy court to halt any lawsuit, action, proceeding or collection effort of creditors. Creditors who are listed in the debtor's petition and schedules are notified of the bankruptcy filing by a written Notice issued from the bankruptcy court that all pending or future collections efforts must cease. It is the automatic stay that stops all self-help collection efforts by creditors and allows the bankruptcy court to control all aspects of the debtor's affairs. Reading the complete text of Section 362 is not meant for a light, bedtime reading. The twists and turns in the statute test both the patience and understanding of bankruptcy attorneys. A complete copy of 362 is included at the end of this manuscript for those who want to experience the agony of reading something prepared by congressional statute-writers. Section 362(a) prohibits any party from "the commencement or continuation" of a judicial, administrative or other action against the debtor to collect on a debt or recover assets of the estate. The language used in 362(a) is broad and intended to encompass a wide array of collection efforts, and creditors who seek permission to begin or complete state/federal court litigation must first demonstrate that "good cause" exists under 362(d) to lift the automatic stay. "Good cause" is not defined in 362(d), except that it includes "the lack of adequate protection of an interest in property" or when the debtor does not have equity in such property and the property "is not necessary to an effective reorganization". When a debtor files bankruptcy and there are actions pending in another forum concerning property of or a claim against the estate, what is the test for determining whether the automatic stay should be lifted to allow that action to proceed against the debtor? EQUITABLE DISTRIBUTION ACTIONS. Perhaps the most familiar situation involving lifting the stay (other than a creditor who seeks to foreclose on property) is when a spouse of the debtor seeks to pursue a state court action for child support, alimony and equitable distribution. Section 362(b)(2) excepts from the automatic stay any action to establish paternity, child 1

2 custody or visitation, domestic support obligations and the dissolution of a marriage; however, 362(b) does not lift the stay for an action that "seeks to determine the division of property that is property of the estate". A spouse or former spouse has a pre-petition right to assert an equitable distribution claim against the debtor, but such a claim does not give the spouse a specific right to any particular property of the estate. See Wilson v. Wilson, 325 S.E.2d 668 (N.C.App. 1985). Thus, at separation neither party has a lien on specific marital property, but each spouse does have a "claim" to such property. Kroh v. Kroh, 571 S.E.2d 643 (N.C.App. 2002). Interestingly, if the spouse does not file an action for equitable distribution before the bankruptcy is filed, the spouse has an "unsecured "claim" against the bankruptcy estate, but if the spouse does file an ED lawsuit pre-petition, the "claim" created is still an unsecured, unliquidated and contingent claim. A holder of an unliquidated, contingent claim is allowed to have that claim estimated if the fixing or liquidation of that claim would unduly delay or interrupt the administration of the bankruptcy case. This is particularly apt to situations involving a division of marital property, since bankruptcy courts are not well-equipped to handle equitable distribution claims. In most instances, the bankruptcy court will lift the stay to allow the spouse to establish her right to an equitable distribution, but not to allow the state court to grant ownership of specific property of the estate. See In re Linville, Case No C-7W (Bankr. M.D.N.C. 2005); In re Diaz, Case No C-7G (Bankr. M.D.N.C. 2004). The bankruptcy court reserves its authority to decide whether the spouse's claim is entitled to be recognized over the claims of other creditors. FEDERAL/STATE COURT PERSONAL INJURY TORT CLAIMS. After equitable distribution claims, tort claims present the next largest category of situations where creditors seek to lift the automatic stay. Tort claims present the possibility that the debtor may have engaged in intentional actions which are not dischargeable in bankruptcy. Here, the interests of the debtor and the trustee are loosely aligned with one another, as both view the assertion of an unliquidated, contingent claim pending in another forum as a threat to the payment of other creditors. Personal injury torts are dealt with specifically in 11 U.S.C. 157 as a jurisdictional limitation on the bankruptcy court's powers. Section 157(b)(5) provides that "[t]he district court shall order that personal injury tort and wrongful death claims shall be tried in the district court in which the bankruptcy case is pending, or in the district court in which the claim arose... In In re Nifong, Case No C-7D (Bankr. M.D.N.C. 2008), the Middle District Bankruptcy Court has adopted the broad view that any injury which is an invasion to the person or personal rights is a "personal injury tort". The debtor in Nifong was the former district attorney of Durham County, NC who investigated the Duke men's lacrosse team on possible rape allegations. Nifong was alleged to have concealed evidence and made false statements during his investigation of the Duke players, ultimately resulting in the dismissal of all charges against the Duke players. Shortly after leaving office, the debtor filed a Chapter 7 bankruptcy seeking to discharge 2

3 all claims asserted by the Duke team members. In response, various team members filed lawsuits in federal court for malicious prosecution, concealment of evidence, fabrication of evidence, conspiracy to obstruct justice, conspiracy to tamper with witnesses and intentional infliction of emotional distress. They sought to have their claims declared non-dischargeable as willful and malicious personal injuries. The Nifong court began its analysis of the case by noting that 362(d) requires the moving party to show "cause" why the stay should be lifted. The court rejected the need for a balancing test to determine whether the potential prejudice to the debtor is outweighed by the hardships of the moving party if they are required to pursue the litigation in bankruptcy court, citing 157(b)(5) as the basis for its position. The Nifong court evaluated each claim asserted by the Duke players and found that all of the claims sounded tort, in that each act allegedly committed by the debtor was an act against the personal civil rights of the players. Consequently, the Nifong court lifted the stay as to all player claims. "PROPERTY" TORT CLAIMS. Aside from personal injury torts, there are civil claims for damages to property which are stayed by 362. Claims for misappropriation of trade secrets, fraud and unfair and deceptive trade practices are examples of types of "property" tort claims, in that the injury is not to the body of the person. Because 362(d) does not define what constitutes "cause" for these types of claims, the bankruptcy court must exercise its discretion on a case-by-case basis. The courts have focused primarily on these factors: a) whether the issues in the pending litigation involve only state law, so that the expertise of the bankruptcy court is not needed; b) whether modifying the stay will promote judicial economy; c) whether there would be greater interference with the bankruptcy case if the stay were not lifted because matters would have to be litigated in bankruptcy court; and d) whether the estate can be protected properly by a requirement that creditors enforce in bankruptcy court any judgment obtained by the creditor. See In re Robbins, 964 F.2d 342 (4th Cir. 1992). In In re Allred, Case No C-13G (Bankr. M.D.N.C. 2004) the court addressed the question of lifting the automatic stay to allow a creditor to proceed in state court on claims of However, the term "personal injury tort" is not defined in either Title 11 or Title 28, and there is a split of authority as to what constitutes a personal injury tort. The more restrictive view interprets the phrase narrowly, holding that the tort must involve trauma or bodily injury. In re Stron of Michigan, 172 B.R W.D.Mich. 1994; In re Cohen, 107 B.R. 453 (S.D.N.Y. 1989). This line of cases holds that the injury must be beyond mere shame and humiliation and must involve an injury to the person. The more broad view holds that the traditional "injury to the body" does not matter; rather, the focus is on whether the injury, whether physical or psychological, constitutes a recognizable tort against the person of the creditor. These torts may go beyond the traditional type of personal injuries involving pain and suffering to include libel, slander, unlawful harassment or discrimination based on sex, race and gender, criminal conversation, malicious prosecution, false imprisonment and mental suffering. 3

4 In In re Joyner, Case No C-13D (Bankr. M.D.N.C. 2009), a church was a plaintiff/creditor in a state court action against the debtor for unfair and deceptive trade practices. The debtor subsequently filed a Chapter 13 petition, and the church requested relief from the automatic stay to proceed with its lawsuit. While the Joyner court paid passing tribute to the Robbins factors for determining when the stay should be lifted, the court avoided analyzing those factors. Instead, the court found that the creditor had filed a proof of claim in the case, and that sooner or later the validity of the claim must be resolved. The court also found the claim was strictly a state law issue that did not require any bankruptcy expertise. Because of these considerations, the Joyner court lifted the stay to allow the state law claim to proceed to judgment, but prohibited enforcement of any judgment by the state court. Another instance involving a motion for relief from stay to pursue a state law property claim is found in In re Hogan, Case No C-7G (Bankr. M.D.N.C. 2004). In Hogan, the debtor listed as an asset in his Chapter 7 schedules a tract of land in Oklahoma. Prior to the debtor filing bankruptcy, the creditor had filed a state court action in Oklahoma for specific performance against another party which allegedly owned an interest in the same land. The creditor moved to lift the automatic stay to allow the state court lawsuit to continue on. The debtor was not a named as a party in the Oklahoma state court action, but the Trustee argued that any decision by the state court might be prejudicial to interests of an asset of the estate. Here, the Hogan court specifically acknowledged the Robbins factors and engaged in the correct Robbins analysis. The court specifically focused on whether a state court action in Oklahoma would actually promote judicial economy or whether the estate's interests could be adequately protected in an action in Oklahoma in which the debtor was not a party. Deciding that the debtor had claimed the land was property of the bankruptcy estate, the court found that the only way to protect such an asset was to require the creditor to come into bankruptcy court to press its claims. The court denied the creditor's motion for relief from stay. ADMINISTRATIVE PROCEEDINGS/CLAIMS. Section 362 was designed to allow the debtor some "breathing room" from creditors so that the debtor can fashion a plan or reorganization of an orderly liquidation of assets. However, 362 has numerous exceptions to allow certain actions or proceedings not involving the collection of money to proceed in an orderly manner. Administrative actions by governmental bodies, other than to collect money, may be permitted to proceed under 362(b(4). In In re Pinkney, Case No C-13W (Bankr. M.D.N.C. 2002), the court considered whether the automatic stay was in effect, and if so whether to lift the stay, to allow a regulatory action by the North Carolina State Board of CPA Examiners to proceed with enforcing a Consent Order of suspension of the debtor's CPA license. In Pinkney, the Chapter 13 debtor claimed the automatic stay was in effect prohibiting the Examiners Board from enforcing the Consent Order, since by doing so the debtor would be deprived of her sole source of gainful employment necessary to fund her Chapter 13 bankruptcy. The debtor objected to the motion for relief from stay, contending that the Examiners Board action was affecting a pecuniary interest of the estate. Alternatively, the debtor argued that the court should use its equitable powers under 105 to enjoin the Examiners Board from enforcing the Consent Judgment. The 4

5 Examiners Board argued that it was simply enforcing its police powers to suspend a licensed member who had violated rules and regulations protecting the public's welfare from those who have engaged in deceptive, discreditable conducted, and that the automatic stay, if it was in effect, should be lifted to allow enforcement to proceed. The court examined the nature of the CPA Examiner's state court lawsuit, noting that it did not contain any claims for the collection of money. Rather, the action was instituted under the regulatory police powers of the Examiners Board, whose obligation is to protect the public from harm by unscrupulous or unlicensed accountants. The court also noted that 364(b)(4) excepts from the automatic stay the commencement or continuation of an action by a governmental unit to enforce the organization's police or regulatory powers involving the debtor. The court found that the Examiners Board was a governmental unit as described in 364(b)(4) and therefore the Board's action was not stayed by the debtor's Chapter 13 filing. Not surprisingly, the Pinkney court rejected the debtor's 105 argument, stating that its equitable powers are limited to actions "which are necessary or appropriate to carry out the provisions of this title". The court refused to consider enjoining an action which was expressly allowed under 364(b)(4), and denied the debtor's motion to stay the action. bankruptcy case is pending or in the district court in which the claim arose. North Carolina has adopted the more broad view that any claim which is for injury to the person or body of the creditor is a "personal injury tort" that may not be tried in the bankruptcy court. Other "property tort" claims which involve the debtor's injury to the creditor's property interests may also constitute cases where the bankruptcy should refuse to exercise its jurisdiction, provided the creditor can show the balance of the Robbins factors are in its favor. Kevin W. Whiteheart is the principal manager of WHITEHEART LAW FIRM, PLLC in Winston-Salem, NC. He is a 1988 graduate of CAMPBELL UNIVERSITY SCHOOL OF LAW and received an M.B.A. from the BABCOCK GRADUATE SCHOOL OF MANAGEMENT at WAKE FOREST UNIVERSITY in He writes articles frequently on legal issues in bankruptcy, construction law, divorce law, employment law and business. Copyright WHITEHEART LAW FIRM, PLLC. All Rights Reserved. CONCLUSION Creditors possessing federal or state law claims against a debtor may obtain relief from the automatic stay to pursue those claims, provided the creditor can satisfy the balance of the Robbins factors in its favor. Under 11 U.S.C. 157(b)(5), personal injury torts actions against debtors must be tried in the district court in which the 5