There is more than one way that a creditor of a bankrupt entity (or debtor) can directly prosecute its claims in bankruptcy.  If the creditor is involved in prepetition litigation with the debtor, it could request relief from the automatic stay to continue liquidating its claim against the debtor in a non-bankruptcy forum, pursuant to 11 U.S.C. § 362(d)(1).  It could also remove the prepetition lawsuit to federal court, pursuant to a couple of removal statutes, including 28 U.S.C. §§ 1441 and 1452.

If no prepetition litigation exists, the creditor could initiate its own adversary proceeding against the debtor, pursuant to Bankruptcy Rule 7001.  The creditor could also simply file a proof of claim and participate in the normal claims resolution process, pursuant to certain provisions in Chapter 5 of the Bankruptcy Code and the 3000 Rules of Bankruptcy Procedure.

Each of these remedies carry advantages and disadvantages, depending on the circumstances.  But, the one thing a creditor must keep in mind is that it cannot simply pursue any of these remedies without following certain restrictions pertaining to each.  The consequences could be detrimental to the creditor’s claim.

Take, for example, the recent case of In re Roman Catholic Church of the Archdiocese of Santa Fe, Case No. 18-13027-t11 (Bankr. D. N.M. May 13, 2021) [ECF 696], where Judge Thuma recently adopted the minority position, holding that a creditor cannot prosecute its prepetition claim in a debtor’s bankruptcy case, without first obtaining relief from the automatic stay.  The Court dismissed the creditor’s efforts in the Archdiocese of Santa Fe case–albeit without prejudice.

Facts

The debtor was a Roman Catholic Church in Santa Fe.  Prepetition, the creditor alleged that the debtor continuously defamed him, by including his name on several public releases that included lists of certain church officials accused of committing certain crimes.

The creditor claimed that he was not one of those church officials and made several pleas for the debtor to cease making such public releases.  But, the debtor would not.  Eventually the creditor sued the debtor for defamation, invasion of privacy and intentional inflection of emotional distress.  During the middle of this lawsuit, the debtor filed bankruptcy.

In the bankruptcy, the creditor filed a proof of claim for his alleged damages for his state court claims.  While he conceded that the automatic stay applied to his state court action, he also filed a motion in the Bankruptcy Court essentially requesting that the debtor be enjoined from continuing to publish his name on press releases.  This motion is the focus of the Court’s opinion.

Analysis

The Court first found that, while the creditor’s motion included equitable relief that was not originally included in the creditor’s state court action, it was still the commencement of a judicial proceeding against the debtor that “could have been commenced before the commencement of the case,” as proscribed by section 362 of the Bankruptcy Code.  See 11 U.S.C. §§ 362(a)(1).  This made the new claim enjoined by the automatic stay.

The Court next addressed the more thornier issue of whether “it violates the automatic stay for a creditor to sue the debtor in bankruptcy court on a prepetition claim.”

Majority View

The majority rule is that creditors can bring such suits in bankruptcy court without violating the stay.  See, e.g., In re North Coast Village, Ltd., 135 B.R. 641, 643 (9th Cir. BAP 1992); In re Transcolor Corp., 296 B.R. 343, 358 (Bankr. D. Md. 2003); In re Uni-Marts, LLC, 404 B.R. 767, 783 (Bankr. D. Del. 2009); see also In re Miller, 397 F.3d 726, 730 (9th Cir. 2005); In re Cashco, 599 B.R. 138, 146 (Bankr. D.N.M. 2019); In re Bird, 229 B.R. 90, 95 (S.D.N.Y. 1999)).

The majority’s reasoning is based, in large part, on practical concerns; i.e., there are many things that a creditor does in bankruptcy to advance it’s claim, like filing or prosecuting a proof of claim or filing a motion to lift the stay.  Thus, applying the stay to every such effort would lead to absurd results.

Minority View

The minority view is based on the plain language of section 362(a)(1), which expressly proscribes the filing of a proceeding again the debtor in bankruptcy on a prepetition claim.  See, e.g., Bridges v. Continental AFA Dispensing Co. (In re Continental AFA Dispensing Co.), 403 B.R. 653, 659 (Bankr. E.D. Mo. 2009); Healy/Mellon-Stuart Co. v. Coastal Group, Inc. (In re Coastal Group, Inc.), 100 B.R. 177, 178 (Bankr. D. Del. 1989); In re Hodges, 83 B.R. 25, 26 (Bankr. N.D. Cal. 1988); In re Penney, 76 B.R. 160, 161 (Bankr. N.D. Cal. 1987) (creditor cannot initiate adversary proceeding under Fed. R. Bankr. P. 7001 without leave of court); see also In re Ionosphere Clubs, Inc., 922 F.2d 984, 993 (2d Cir. 1990) (automatic stay applies to dispute between debtor and union over a
collective bargaining agreement, even if the matter is brought before the bankruptcy court).

Court’s Opinion

Judge Thuma sided with the minority view, agreeing that the plain language of section 362(a)(1) is clear and disagreeing that the enforcement of such provision would lead to absurd results, because the practical examples cited by the majority specifically arise under the Bankruptcy Code and could not have been brought prepetition.  See, e.g., Hodges, 83 B.R. at 26 (“[a]n action taken in the bankruptcy court can only be found to be a violation of the automatic stay when there is no basis under the Code for the action”).

The Court also distinguished suing a debtor in bankruptcy from filing a proof of claim, in that the latter proceeding involves a contested matter (not an adversary proceeding) and the debtor has control over the claims administration process, which is “far more efficient” than a suit.

Thus, the Court voided the creditor’s motion for equitable relief–which was deemed to be akin to an adversary proceeding–and  held that the creditor had to, first, file a lift stay motion and, second, file an adversary proceeding, to prosecute its equitable relief during the debtor’s bankruptcy (pursuant to bankruptcy Rule 7001(7)).  Alternatively, the creditor could remove its state court lawsuit to bankruptcy court, pursuant to Bankruptcy Rule 9027, which provides, in part, that removal can occur 30 days after a lift stay motion is granted.

Takeaway

There are grey areas in the Bankruptcy Code, just like any other law.  While Judge Thuma adopts the minority view with respect to postpetition suits, one of the real benefits of his guidance in Archdiocese of Santa Fe is that it reminds creditors to err towards the side of caution when delving into the grey areas, especially with respect to the automatic stay–or, at least, check which view your local jurisdiction has adopted.