Second Circuit Finds Willful Breach of Stay in Foreclosure Sale of Nondebtor’s Real Estate

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On July 6, 2022, the Court of Appeals for the Second Circuit (the Circuit Court), in analyzing a matter of first impression, issued a decision clarifying the broad applicability of the automatic stay provision of the Bankruptcy Code. In Bayview Loan Servicing LLC v. Fogarty (In re Fogarty), no. 20-2187, 2022 US App. LEXIS 18515 (2d Cir. July 6, 2022), the Circuit Court was asked to determine whether the automatic stay provision of Bankruptcy Code Section 362(a) was violated by the foreclosure sale of real estate where the debtor was a named defendant in the underlying foreclosure proceeding, even if the debtor’s direct interest in the property was merely possessory. In affirming the decision of the District Court for the Eastern District of New York (the District Court), which overturned an earlier decision of the Bankruptcy Court for the Eastern District of New York (the Bankruptcy Court), the Circuit Court found that the foreclosure sale was a willful violation of the automatic stay.

Factual background and history of the proceedings

Eileen Fogarty (the Debtor) held a 99% interest in 72 Grandview LLC (Grandview), which was the sole owner of a residential property located in Shirley, New York (the Property), which was also the principal residence of the Debtor. Bayview Loan Servicing LLC (Bayview) filed a foreclosure action (the Foreclosure Action) against the Property in early 2011 in the Supreme Court of the State of New York, Suffolk County (the State Court). Initially, Bayview named, among others, Grandview and John Does #1-50, but not the debtor, as defendants in the foreclosure action. However, in October 2014, Bayview requested that Debtor be replaced as defendant in place of John Doe #1 as “co-tenant in possession of part of” the property.[1] In early 2018, the State Court seized a Foreclosure and Sale Judgmentnaming the debtor as a defendant, and Bayview has scheduled a foreclosure sale of the property for April 17, 2018.

On April 13, 2018, four (4) days before the scheduled date of the forced sale of the property, the debtor filed a petition for relief under Chapter 7 with the bankruptcy court. The Debtor’s attorney subsequently advised Bayview’s attorney that: (i) the Debtor had applied for Chapter 7 protection; (ii) the continuation of the sale with foreclosure would violate the automatic stay of section 362(a) of the Bankruptcy Code; and (iii) the Debtor would seek costs, fees and penalties for such breach of stay. Bayview’s attorney responded that since Grandview, not the debtor, and not the debtor, was the legal owner of the property and is legally separate from the debtor, the automatic stay was inapplicable. Bayview then proceeded with the foreclosure sale as planned.

The debtor subsequently sought sanctions against Bayview in bankruptcy court, alleging willful violations of Sections 362(a)(1) and (a)(2) of the Bankruptcy Code, and seeking damages. actual, costs, fees and punitive damages. In denying the motion, the bankruptcy court held that because the debtor could not be held liable under the loan documents in question, executed solely by Grandview, the foreclosure action was only in rem and Bayview did not breach the automatic stay by proceeding with the sale. On debtor’s appeal, the district court reversed the bankruptcy court’s decision, finding that Bayview willfully violated the automatic stay because: (i) debtor was a named defendant in the foreclosure action; and (ii) the sale interfered with the debtor’s right of possession to the property, which right was owned by the debtor’s Chapter 7 estate. Bayview appealed to the Circuit Court.

The Circuit Court’s Justification

The filing of a bankruptcy petition by a debtor “acts as a stay, applicable to all entities”, including: (i) the continuation of legal action “against the debtor” that was commenced before the bankruptcy file;[2] and (ii) “the enforcement, against the debtor or against the property of the estate, of a judgment obtained before the commencement of the action under” the Bankruptcy Code.[3]

In analyzing these two (2) provisions of the Bankruptcy Code, the Circuit Court first noted that actions “against the debtor”, as used in Section 362(a)(1), must naturally encompass actions in which the debtor is a named defendant.[4] Therefore, as the debtor was replaced as a defendant in the foreclosure action, the Circuit Court could only “find that the foreclosure action was ‘against the debtor’ and therefore covered by Section 362 ( a) (1)”.[5] The circuit court further noted that the debtor remained as a named defendant in the foreclosure action from its replacement until the sale of the property, as evidenced by the caption in the pleadings filed in court. of state.[6] It follows that the foreclosure sale was a “continuation” of a pre-bankruptcy action against the debtor and, therefore, was subject to the automatic stay.[7]

With respect to Section 362(a)(2) of the Bankruptcy Code, the Circuit Court noted that since the foreclosure judgment was entered on February 14, 2018, and the debtor sought Chapter 7 protection on April 13, 2018, the judgment was undoubtedly “obtained before the start of the debtor’s “Chapter 7 case”.[8] Further, the sale of the Property was “forced execution, against the [D]debtor. . . of a judgment. . . .”[9] Specifically, the foreclosure judgment authorized the sale of the property by a court-appointed arbitrator, the judgment was binding on all defendants under it, and the debtor was a party defendant in the foreclosure action until at least until the sale.[10] The Circuit Court concluded its analysis of Section 362(a) by stating that its wording “requires a clear rule that so long as the debtor is a named party in a proceeding or action, the automatic stay applies to the continuation of these proceedings and the execution of a judgment rendered in these proceedings”.[11]

In reviewing the bankruptcy court’s decision, the circuit court also rejected Bayview’s argument that because the foreclosure action was a in rem proceeding and the debtor was named as a defendant only as an “interested party”, there was no effect on the debtor’s Chapter 7 estate.[12] The Circuit Court noted that Section 362(a) of the Bankruptcy Code does not distinguish between in rem and in person procedure, nor inquires about Why a debtor is named as a defendant in a legal proceeding.[13] On the contrary, its plain text remains clearly the “continuation. . . of a judiciary. . . action or suit against the debtor who was . . . commenced before the opening of the case” under the Bankruptcy Code.[14]

Conclusion

Lawyers for creditors and other interested parties in bankruptcy proceedings should endeavor to heed the warnings that: (i) “the automatic stay[esttout-puissantetexemptdecompromis»;[15] and (ii)”[w]chicken in doubt. . . file a motion for relief. . . .”[16] As demonstrated in Bay view, a willful violation of the Automatic Stay most often results in significant, and almost always avoidable, monetary penalties against the offending party. Indeed, under Section 362(k) of the Bankruptcy Code, a party found to have willfully breached the automatic stay is not only liable for the debtor’s actual damages, including costs and attorneys’ fees , but also, in certain circumstances, punitive damages.[17] As such, it is often in a party’s interest to request a stay when the enforceability of the stay is in question. “Put bluntly, the system requires a creditor to seek permission, not forgiveness.”[18]

If you have any questions or would like additional information, please contact Travis Powers ([email protected]; 212.868.4837).


[1] Fogarty, 2022 US app. LEXIS 18515, at *5.

[2] 11 USC § 362(a)(1).

[3] 11 USC § 362(a)(2).

[4] Fogarty, 2022 US app. LEXIS 18515, at *13.

[5] Fogarty, 2022 US app. LEXIS 18515, at *13.

[6] Fogarty, 2022 US app. LEXIS 18515, at *13.

[7] Fogarty, 2022 US app. LEXIS 18515, at *13-14.

[8] Fogarty, 2022 US app. LEXIS 18515, at *14 (quoting 11 USC § 362(a)(2)).

[9] Fogarty, 2022 US app. LEXIS 18515, at *14.

[10] Fogarty, 2022 US app. LEXIS 18515, at *14.

[11] Fogarty, 2022 US app. LEXIS 18515, at *15.

[12] Fogarty, 2022 US app. LEXIS 18515, at *17-18.

[13] Fogarty, 2022 US app. LEXIS 18515, at *18.

[14] Fogarty, 2022 US app. LEXIS 18515, at *18. The Circuit Court summarily dismissed the remainder of Bayview’s arguments: (i) that the foreclosure sale was merely an act of government; (ii) that Bayview was not an interested party and therefore could not request a stay; and (iii) that fairness required that the Circuit Court set aside the District Court’s decision.

[15] Stopped. Committee. From Unesec. Creditors c. Provident Nat Bank (In re Un. Church of the Ministries of God)74 BR 271, 275 (Bankr. ED Pa. 1987).

[16] Top Roofing, Inc. c. Roy Kirby & Sons, Inc. (In re Top Roofing, Inc.)no. 12-00041, 2013 WL 5636628, at *37 (Bankr. D.Md. 15 Oct. 2013).

[17] 11 USC § 362(k).

[18] In re Stefani, no. 18-00395-LT13, 2019 Bankr. LEXIS 481, at *43 (Bankr. SD Cal. Feb. 15, 2019).

This correspondence should not be construed as legal advice or legal advice on specific facts or circumstances. The Content is intended for general informational purposes only and you are urged to seek legal advice regarding your own situation and legal matters.

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