A bankruptcy stay may protect property owned by the debtor but not owned. Nexen Pruet, PLLC

[co-author: Andrew Kragie, Law Clerk]

According to a recent decision by the New York-based Federal Court of Appeals, an automatic stay caused by a bankruptcy filing may protect a debtor’s residence even if the debtor doesn’t own the property.

In a first impression case, decided in July 2022, the Second Circuit ruled that the bankruptcy code’s automatic stay provision “can be imposed by a foreclosure sale of real property, even if the debtor is the named party to the foreclosure proceeding.” I set a clear rule that it will be violated. If the debtor holds only title to the property. ” About Fogarty39 F.4th 62, 71 (2d Cir. 2022). It was something.

A fundamental principle of corporate law is that an LLC is a separate legal entity from its members, and the members do not have ownership of the assets owned by the company, so this decision may surprise some creditors. I have. Therefore, if a member of the LLC files a bankruptcy petition, assets owned solely by the LLC do not constitute property of the debtor’s bankruptcy estate and are not necessarily protected from collection efforts by automatic suspension. However, if a member in bankruptcy retains title to a home owned by a non-debtor LLC, the member’s ownership interest itself becomes property of the bankruptcy estate and is eligible for automatic termination protection.

in the Fogerty In this case, each debtor lived in a house owned by an LLC in which the debtor held a 99% membership. The house was mortgaged to secure the debt owed by the LLC. Before the debtor went bankrupt he filed a foreclosure action in state court when the LLC defaulted on the mortgage. The LLC was initially the sole named defendant in the foreclosure action, but the servicer later added the debtor as a defendant. The servicer obtained a judgment granting the foreclosure sale.

Four days before the scheduled foreclosure sale, the individual debtors filed Chapter 7 bankruptcy. The debtor’s attorney called the servicer the night before the sale and said her automatic suspension prevented the foreclosure sale, even though she didn’t own the property because the property was the debtor’s residence. claimed. The servicer dismissed this claim on the grounds that the debtor’s petition for personal bankruptcy did not protect the assets owned by her LLC. The servicer could have asked the bankruptcy court for reprieve to allow the sale of the foreclosure, but the servicer chose not to do so. The sale took place and the third-party purchaser evicted the debtor after securing relief from the automatic suspension.

The debtor has filed a motion in her bankruptcy case seeking sanctions against the servicer for willful breach of automatic suspension. The bankruptcy court dismissed the claim, but the district court reversed it on appeal, determining actual damages and directing the bankruptcy court to consider punitive damages. The Second Circuit Court of Appeals affirmed the district court’s decision in favor of the debtor.

It remains to be seen whether other courts will follow the Second Circuit’s precedent. The Court of Appeals for the Fourth Circuit has ruled that, at least for nonresidential property, “[a] Mere ownership under an expired lease is not sufficient to trigger an automatic stay. . at Premier Auto.Serves Co., Ltd.., 492 F.3d 274, 281 (4th Cir. 2007).

In the absence of clear authority, prudent creditors seek reprieve to avoid potentially costly consequences. A creditor found to have breached the automatic suspension may be ordered to pay the debtor’s actual damages, including attorneys’ fees. In some jurisdictions, you may also be ordered to pay damages for emotional distress. A creditor may also face punitive damages if the bankruptcy court determines that the creditor acted in bad faith or with reckless neglect and actual knowledge of the stay. A creditor with a record of breach of stay may be presumed to have acted in bad faith in favor of an award of punitive damages.

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