If The Person or Company I Sued Filed Bankruptcy Can I Continue My State Court Lawsuit?

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The greatest grant of power to the bankruptcy court is the automatic stay stopping any and all collection activity including lawsuits. As soon as the petition for bankruptcy is filed the automatic stay takes effect. Section 362 of the Bankruptcy Code governs the automatic stay and relief from the automatic stay to continue collection activity with the bankruptcy court’s permission. So what circumstances need to exist to obtain relief from the automatic stay and continue prosecution of a state court lawsuit?

What Is The Automatic Stay?

The automatic stay among other things, prohibits creditors from continuing to prosecute prepetition litigation against the bankruptcy filer. § 362(a)(1); see also In re Conejo Enterprises, Inc., 96 F.3d at 351. This aspect of the automatic stay protects both the debtor and the debtor’s creditors. The entire point is to not allow one creditor to continue collection to the detriment of another creditor. The assets of the bankruptcy filer, once a case is filed, if any assets, are to be distributed equally to creditors at the time the case is filed.

Grounds For Relief From The Automatic Stay To Continue State Court Lawsuit

This issue arises quite a bit under many different circumstances. The most common lawsuit that exists at the time a bankruptcy case is filed is breach of contract lawsuits. Rarely will a breach of contract case satisfy the requirements for relief from stay to continue. Relief from the automatic stay can be obtained for “cause.” The Bankruptcy Code unfortunately does not define what “cause” is though. Courts have had to interpret circumstances and create factors to evaluate. The Ninth Circuit uses the Curtis factors. See In re Curtis, 40 B.R. 795, 799–800 (Bankr. D. Utah 1984).

The Curtis factors consist of the following twelve nonexclusive factors:

(1) Whether the relief will result in a partial or complete resolution of the issues;
(2) The lack of any connection with or interference with the bankruptcy case;
(3) Whether the foreign proceeding involves the debtor as a fiduciary;
(4) Whether a specialized tribunal has been established to hear the particular cause of action and whether that tribunal has the expertise to hear such cases;
(5) Whether the debtor’s insurance carrier has assumed full financial responsibility for defending the litigation;
(6) Whether the action essentially involves third parties, and the debtor functions only as a bailee or conduit for the goods or proceeds in question;
(7) Whether the litigation in another forum would prejudice the interests of other creditors, the creditors’ committee and other interested parties;
(8) Whether the judgment claim arising from the foreign action is subject to equitable subordination under Section 510(c);
(9) Whether movant’s success in the foreign proceeding would result in a judicial lien avoidable by the debtor under Section 522(f);
(10) The interests of judicial economy and the expeditious and economical determination of litigation for the parties;
(11) Whether the foreign proceedings have progressed to the point where the parties are prepared for trial, and
(12) The impact of the stay on the parties and the “balance of hurt.”

The burden of proof on a motion to modify or for relief from the automatic stay is a shifting one. To obtain relief from the automatic stay, the bankruptcy attorney and party seeking relief must first establish a prima facie case that “cause” exists for relief under § 362(d)(1). Once a prima facie case has been established, the burden shifts to the debtor to show that relief from the stay is unwarranted. If the\ movant fails to meet its initial burden to demonstrate cause, relief from the automatic stay should be denied.

Unfortunately there are not clear guidelines for what constitutes a prima facie case given the analysis is on a case by case basis. A party’s production of enough evidence to allow the fact-trier to infer the fact at issue and rule in the party’s favor. See Black’s Law Dictionary (10th ed. 2014); see also In re Planned Sys., Inc., 78 B.R. 852, 860 n.7 (Bankr. S.D. Ohio 1987).

Congress’ legislative comments provide their desire to permit an action to proceed to completion in another tribunal may provide . . . cause” for stay relief, and “it will often be more appropriate to permit proceedings to continue in their place of origin, when no great prejudice to the bankruptcy estate would result, in order to leave the parties to their chosen forum and to relieve the bankruptcy court from many duties that may be handled elsewhere.” H.R. Rep. 95-595, 341, as reprinted in 1978 U.S.C.C.A.N. 5963, 6297

The bottom line is bankruptcy attorneys need to be aware that the bankruptcy court’s focus on whether the continuation of the state court lawsuit screws up the administration of the bankruptcy estate. In some circumstances insurance is liable for any damages if the lawsuit is successful. Therefore, none of the assets of the bankruptcy estate are at risk either way. So why not let the lawsuit continue?

Why Continue With State Court Lawsuit?

To get a judgment and hopefully paid on the judgment. The most common lawsuit that exists at the time a bankruptcy case is filed is breach of contract lawsuits. Rarely will a breach of contract case satisfy the requirements for relief from stay to continue. There are other types of issues though that can continue and not disrupt the administration of the bankruptcy estate.

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