Though not binding in Minnesota yet, the U.S. Court of Appeals for the Second Circuit’s recent decision relating to the automatic stay in bankruptcy is causing some angst across the nation. A creditor loan servicer in New York received something of a shock in July 2022, when the U.S. Court of Appeals for the Second Circuit ruled that its 2018 foreclosure sale of an LLC’s defaulted property violated the automatic stay provisions of 11 U.S.C. § 362 simply because the person living on the property had filed for bankruptcy. The Second Circuit held, in in re Fogarty, that when a party is in bankruptcy, no actions in which “the debtor is a named party” can proceed, even if, as in Fogarty, the debtor herself is not the party being foreclosed upon. The court wrote, “any action or proceeding ‘against the debtor’ is stayed, regardless of whether the debtor was purportedly named as merely an interested or nominal party or as some other kind of defendant.”
Creditors are no doubt familiar with the automatic stay provisions of U.S.C. § 362. After a debtor files for bankruptcy, creditors are stayed from pursuing actions against the debtor, such as foreclosures or evictions. The scope of the protection is broad. Creditors cannot commence a new action, nor can they continue an existing action against the debtor or recover upon a claim that arose before the debtor filed for bankruptcy. 11 U.S.C. § 362(a)(1). Creditors are also prevented from enforcing any existing judgment against the debtor or any property contained in the bankruptcy estate. 11 U.S.C. § 362(a)(2).
In Fogarty, Bayview Loan Servicing held a mortgage on a property owned by an LLC. Eileen Fogarty held a 99 percent interest in the LLC, and also lived on the property. When the LLC defaulted on the mortgage, Bayview brought a foreclosure action and was granted a judgment permitting it to dispose of the property in a foreclosure sale. Four days before the sale was to occur, Fogarty personally filed for bankruptcy, triggering an automatic stay upon actions or judgments against her. The LLC never applied for bankruptcy and was never explicitly protected by an automatic stay, so Bayview’s belief was that, since the property was in the LLC’s name, the sale was not covered by any stay and the foreclosure sale could proceed.
After the foreclosure sale, Fogarty sued Bayview in bankruptcy court, but the judge agreed with Bayview’s interpretation of the automatic stay rule. Fogarty appealed to the district court for the Eastern District of New York, which ruled in Fogarty’s favor. Bayview appealed to the Second Circuit, which also held for Fogarty and gave its “bright-line rule” the precedential power in the states of the Second Circuit, which includes New York, Connecticut and Vermont. The court did not state that the property was protected because a bankrupt debtor lived on it, but rather, quite simply, that because Fogarty was a named party in the foreclosure action, alongside the LLC, the foreclosure sale should have been stayed because one of the defendants, Fogarty, was protected by the automatic stay in bankruptcy. Unless an appeal to the U.S. Supreme Court follows, Bayview will have to pay damages to Fogarty for violating the automatic stay, even though Bayview—and probably most creditors—would have expected its foreclosure action to be allowable on the basis that it was foreclosing on a non-bankrupt party, the LLC, and was not evicting the bankruptcy debtor.
Precedent on the automatic stay in Minnesota is largely guided by Bernick v. Caboose Enterprises, Inc. (1986), which interpreted the automatic stay as providing “a focal point for all legal actions and claims against the debtor’s property—the bankruptcy court.” The Bernick ruling interpreted the automatic stay as temporarily removing all power over the debtor from the district courts and placing the debtor solely under the jurisdiction of the bankruptcy court until the bankruptcy proceedings are complete. Any judgment rendered by any other court in the meantime will be voided. However, the court described the bankruptcy court’s jurisdiction as being “over the [bankruptcy] estate of the debtor,” which is not as broad as the Second Circuit’s interpretation that the bankruptcy court has sole jurisdiction over any action connected with the debtor. The wording of the Bernick decision would appear to support Bayview’s argument against Fogarty, had that case been before a Minnesota court.
To be on the safe side, creditors should take advantage of the option of seeking a bankruptcy court’s permission to proceed against a defendant in district court. In Zahn Law Firm, P.A. v. Baker (2019), the Minnesota Court of Appeals affirmed a district court’s enforcement of a settlement agreement against a debtor in bankruptcy. The creditor had moved the bankruptcy court for permission to proceed with its non-bankruptcy claim in district court, also known as relief from the automatic stay, and the bankruptcy court granted permission. The court held that if a bankruptcy court explicitly permits a creditor to pursue a non-bankruptcy against a bankrupt debtor, the automatic stay is not violated: in effect, the bankruptcy court’s jurisdiction over bankrupt debtors includes the discretion to decide whether a non-bankruptcy action is or is not covered by the automatic stay, and the bankruptcy court may permit actions that it deems not to be covered.
The automatic stay provision derives from a federal statute, so debtors in all states are protected by it, and creditors in all states must abide by it. Different courts interpret the breadth of the automatic stay provision differently, however, as the Second Court decision shows. The Second Circuit’s particular interpretation of the federal statute is not binding on Minnesota state courts or the federal District of Minnesota, but courts often look to decisions in other jurisdictions to guide their own interpretations of the law, so Minnesota creditors should be aware of the Second Circuit’s new “bright-line rule” and keep abreast of any subsequent decisions by which the Second Circuit’s interpretation may spread to other jurisdictions. Certainly, a Minnesota creditor should not be surprised if a similarly-situated debtor cites Fogarty and attempts to persuade the state or District of Minnesota court to adopt the Second Circuit’s interpretation.