IN THE MATTER OF WARDROBE (9TH CIR. 2009) AND STRICT CONSTRUCTION OF RELIEF FROM STAY ORDERS
State-court civil litigation usually involve a breach of some sort of contract (lease, oral agreement, etc.). Then creditors start adding other causes of action (such as fraud, negligence, breach of some duty) to further increase the damages or bullet-proof the complaint from early dismissal. If the defendant files bankruptcy at any point in time prior to entry of judgment, the issue of what happens to the state court case is often litigated in bankruptcy court.
The automatic stay provides that all acts against the debtor that "was or could have been commenced" before the bankruptcy are stayed. 11 U.S.C. 362(a). The main idea is that any claim you had before should now be dealt with inside the context of bankruptcy. However, 11 U.S.C. 362(d) allows for a creditor to seek relief from stay for "cause." Some common examples of "cause" include relief from stay to allow a creditor to continue foreclosure proceedings, to allow a creditor to liquidate a claim and seek recovery from insurance, or to prevent some other risk to the creditor.
The Ninth Circuit recently held that any order granting relief from stay cannot extend to unforeseen causes of action that could be alleged against a debtor. In the matter of Wardrobe, (9th Cir. 2009). In Wardrobe, the bankruptcy court issued an order lifting stay "so that the Creditor may seek to compel the debtor, John Wardrobe, to participate in this trial as a witness and obtain judgment" against a bonding company. The state court case (although temporarily stayed) now proceeded. After the bankruptcy court issued the order, the creditor amended the state court complaint to allege intentional fraud. The creditor obtained default judgment in state court against the debtor and then argued that the elements for 11 U.S.C. 523(a)(2)(A) (nondischargeable claim for fraud) were already established. The debtor argued that the creditor was never authorized by the relief from stay order to obtain a judgment against the debtor for fraud from the state court. The Ninth Circuit Bankruptcy Appellate Panel agreed. The Ninth Circuit affirmed the BAP, but for a different reason.
The Ninth Circuit held that since the creditor never asked the bankruptcy court for permission to seek a judgment for fraud against the debtor, the bankruptcy court's order granting relief from stay could not extend to the fraud cause of action. The state court amendment and the judgment for fraud was in effect void. The Ninth Circuit held that the creditor would have to persuade the bankruptcy court in a separate trial whether or not she could establish the elements of fraud.
The long and the short is that orders granting relief from stay are strictly construed. If there is any doubt that an order for relief from stay covers a particular cause of action and you don't want to end up litigating the same matter twice, it is better to seek clarification from the bankruptcy court as to the scope of an order for relief from stay.
The automatic stay provides that all acts against the debtor that "was or could have been commenced" before the bankruptcy are stayed. 11 U.S.C. 362(a). The main idea is that any claim you had before should now be dealt with inside the context of bankruptcy. However, 11 U.S.C. 362(d) allows for a creditor to seek relief from stay for "cause." Some common examples of "cause" include relief from stay to allow a creditor to continue foreclosure proceedings, to allow a creditor to liquidate a claim and seek recovery from insurance, or to prevent some other risk to the creditor.
The Ninth Circuit recently held that any order granting relief from stay cannot extend to unforeseen causes of action that could be alleged against a debtor. In the matter of Wardrobe, (9th Cir. 2009). In Wardrobe, the bankruptcy court issued an order lifting stay "so that the Creditor may seek to compel the debtor, John Wardrobe, to participate in this trial as a witness and obtain judgment" against a bonding company. The state court case (although temporarily stayed) now proceeded. After the bankruptcy court issued the order, the creditor amended the state court complaint to allege intentional fraud. The creditor obtained default judgment in state court against the debtor and then argued that the elements for 11 U.S.C. 523(a)(2)(A) (nondischargeable claim for fraud) were already established. The debtor argued that the creditor was never authorized by the relief from stay order to obtain a judgment against the debtor for fraud from the state court. The Ninth Circuit Bankruptcy Appellate Panel agreed. The Ninth Circuit affirmed the BAP, but for a different reason.
The Ninth Circuit held that since the creditor never asked the bankruptcy court for permission to seek a judgment for fraud against the debtor, the bankruptcy court's order granting relief from stay could not extend to the fraud cause of action. The state court amendment and the judgment for fraud was in effect void. The Ninth Circuit held that the creditor would have to persuade the bankruptcy court in a separate trial whether or not she could establish the elements of fraud.
The long and the short is that orders granting relief from stay are strictly construed. If there is any doubt that an order for relief from stay covers a particular cause of action and you don't want to end up litigating the same matter twice, it is better to seek clarification from the bankruptcy court as to the scope of an order for relief from stay.
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