Bankruptcy Court Cracks Down on ‘Racing to the Courthouse’: Lessons from In re Klein

The following is a case update written by Hale Andrew Antico, Chief Counsel of Antico Law Firm, analyzing In re Klein, 669 B.R. 877 (Bankr. C.D. Cal. Apr 28, 2025), a recent case of interest:

Summary

In a recent bankruptcy case, the court addressed the interplay between the automatic stay provisions of 11 USC § 362(a) and the standards for imposing sanctions under Taggart v. Lorenzen (2019). While the Supreme Court established an “objectively reasonable basis” test for discharge violations in Taggart, this decision notably applied that standard to determine whether sanctions were appropriate for a violation of the automatic stay. The court found that state court actions filed by entities affiliated with the debtor constituted a stay violation, as they improperly attempted to exercise control over property belonging to the bankruptcy estate. The case centered around a dispute involving life insurance policy proceeds, with the chapter 7 trustee asserting claims on behalf of estate and the respondents filing opposing claims in state court. View the full decision here.

Facts

Life Capital Group, LLC, a California limited liability company established in April 2011, became embroiled in contentious legal proceedings when its co-founder, Leslie Klein, filed for Chapter 11 bankruptcy under subchapter V in February 2023. With Klein holding a 50% membership interest alongside Shlomo Rechnitz, who held the other 50% interest, the company’s governance was outlined in a detailed operating agreement. The case was immediately contentious, and three months after Klein’s case was filed, in response to a motion to dismiss his case, the Court appointed a Chapter 11 trustee.  Thereafter, the bankruptcy proceedings took a dramatic turn when, approximately a month after the trustee initiated an adversary proceeding targeting specific transfers, a number of entities associated with Klein initiated state court actions asserting competing claims to the same life insurance proceeds valued at over $30 million.  The Trustee challenged that action as a violation of the automatic stay and the trustee filed a Motion for Enforcing the Automatic Stay and Sanctions against the Debtor and people and entities associated with the Debtor.

Respondents in the Trustee’s Motion (“Respondents”) contended that neither of their state court actions involved property of the estate (or asserted claims against the Debtor). Specifically, they argued that one does not implicate property of the estate, as Leslie Klein & Associates, Inc. (LKA) sought to recover payments and enforce rights to which it allegedly was entitled prior to any distribution to the Debtor, asserting that these payments never passed through the Debtor’s hands but were instead wrongfully transferred to other parties. Respondents also argued that the second, the EKLK Foundation Action, involves life insurance policies that were never Debtor’s property and, even assuming the policies might later become property of the estate, there is no property in which the Debtor himself owns even an indirect interest unless and until a judgment is entered in favor of EKLK.

Respondents also contested the admissibility of certain documents submitted by the Trustee, but the court overruled their objections upon reviewing the Trustee’s supplemental declaration, and that a trustee can be considered an “other qualified witness” under FRE § 803(6).

LKA further claimed that it was designated as a “lender” in Life Capital’s operating agreement and sought repayment of amounts paid for life insurance premiums before any distributions to the Debtor or Rechnitz. EKLK asserted that it had agreements with another foundation regarding the distribution of proceeds from specific life insurance policies.

The court determined that the state court filings constituted an impermissible exercise of control over property of the estate, thereby violating § 362(a)(3).

Reasoning

In ruling against Respondents, the court interpreted § 362(a)(3) of the Bankruptcy Code. The parties disagreed on the applicability of this provision. 

Section 362(a)(3) states:

Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970 operates as a stay, applicable to all entities, of—

  …any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;

(emphasis in opinion).

To assess whether Respondents had violated the automatic stay, the court applied the three-part test established by the Ninth Circuit in In re Bialac, 712 F.2d 426 (9th Cir. 1983) (the “Bialac test”), which requires examining whether:

• a property interest exists
• whether it is property of the estate under § 541, and
• whether it was altered in a manner contrary to § 362(a).

Analysis of the Automatic Stay and Application of the Bialac Test

The court emphasized that the “scope of the automatic stay is undeniably broad.” Id. Furthermore, specific knowledge or intent to violate the automatic stay is not required; rather, an individual acts at their own risk once aware of the bankruptcy case, unless there exists an “objectively reasonable basis” to believe that the conduct “might be lawful” under the automatic stay.  Id. at 882, citing Taggart v. Lorenzen, 587 U.S. 554, 560 (2019).

1. Property Interest

The court then applied the Ninth Circuit test for determining whether a creditor has violated § 362(a)(3).  Bialac at 429.  First, the court examined whether a property interest existed. Generally, property rights are generally determined by state law. Butner v United States, 440 U.S. 48, 54 (1979).  However, in some instances, property of the estate can include recoveries of avoidance actions under § 541(a)(3) and other claims under § 541(a)(7).

Here, Respondents focused on the life insurance policies and their proceeds. The court, however, emphasized that Debtor’s 50% ownership interest in Life Capital constituted “property.” Moreover, the court noted that legal claims, such as those asserted by the Trustee in this case, are considered a form of intangible property. Id. at 883, citing Sierra Switchboard Co. v. Westinghouse Elec. Corp., 789 F.2d 705, 707 (9^th Cir. 1986).

2. Property of the Estate

Second, the court determined whether, if any rights in property existed, such property was “of the estate” under 11 U.S.C. § 541. Bialac at 429.  The court distinguished between property rights governed by state law and the “property of the estate” under § 541, which encompasses intangible assets such as the Trustee’s legal claims.  As examples, a retirement account would be Debtor’s property but not property of the estate, and avoidance actions would be property of the estate but not the property of Debtor.

Respondents contended that neither state court action involved property of the estate. However, the court rejected this argument, noting that the relevant issue was the “bundle of rights” comprising the Debtor’s equity interests in Life Capital and the rights asserted in the state court actions, as outlined in § 541(a)(1), (3), and (7). Klein, at 884.

3. Alteration of Property

Third, the court determined whether the Respondents’ actions altered the estate’s property interests in a manner contrary to the automatic stay provisions of 11 U.S.C. § 362(a). Bialac at 429-430. The Bialac test’s focus on “alteration of property” is critical here, as Respondents’ actions sought to undermine the trustee’s claim to a 50% equity interest, even if indirectly. Based on these findings, the court concluded that Respondents’ acts were contrary to § 362(a) by altering the estate’s bundle of rights.

In the instant case, Trustee asserted not only a 50% membership interest in Life Capital, including an undivided 50% interest in the residual value of all of its assets after payment to creditors, but also filed a lawsuit asserting claims in the property of Life Capital. Klein at 884. (emphasis in original). A little more than a month after the Trustee asserted those claims, Respondents asserted their own claims in the same property, claiming to have primacy over the interests that the Trustee may have.

The bankruptcy court determined that by filing the state court actions, Respondents attempted to obtain possession of or exercise control over property of the estate. In particular, they were seeking to assert competing interests in the same property that the Trustee was pursuing for the benefit of the estate. Klein at 884-85.

The court explained that Respondents were not precluded from asserting any claims they believed they had. However, the appropriate course of action would have been to seek relief from the automatic stay rather than asserting primacy over the same bundle of rights that the Trustee was pursuing.

Sanctionable Conduct: Respondents’ Violation of the Automatic Stay

After determining that Respondents had violated the automatic stay, the court considered whether sanctions were appropriate. The court applied the applicable standard, as established by a relatively recent Supreme Court ruling. 

The court applied the standard established in Taggart v. Lorenzen, 587 U.S. 554 (2019). Taggart requires courts to assess whether a party had a “reasonable belief” their actions were lawful. Here, the court found no such basis, citing prior warnings and the pattern of “race-to-the-courthouse” tactics. This reinforces that repeated violations, even if not intentional, trigger strict scrutiny under Taggart, which requires “no objectively reasonable basis for concluding that the creditor’s conduct might be lawful” under the automatic stay. Id. at 560. In other words, the court must determine whether there was an objectively reasonable basis for Respondents to believe that their actions did not violate the automatic stay.

The bankruptcy court considered significant that Respondents had previously engaged in similar conduct that violated the automatic stay and were warned by the court about such violations in a prior action. The bankruptcy court had “little trouble concluding that Respondents lacked an objectively reasonable basis to believe that their actions were consistent with the automatic stay. In addition, their filing of the State Court Actions establishes a pattern that, once the estate asserts an interest in an asset, Respondents have attempted to go into State Court to undue or supersede that interest.” Klein  at 885. 

The court found that Respondents’ conduct violated the automatic stay due to the absence of an objectively reasonable belief that their state court actions were lawful under § 362(a)(3), as required by Taggart v. Lorenzen.  However, it should be noted that while the Supreme Court established this standard for discharge violations, its applicability to automatic stay violations remains an open question under Ninth Circuit precedent. The court ordered that it would determine the appropriate dollar amount of those sanctions in future proceedings.

Author’s Commentary

The recent case of In re Klein provides a clear illustration of the automatic stay’s wide reach and the nuanced lessons it offers for practitioners.  Despite the seemingly straightforward statutory language, judicial interpretation of the automatic stay continues to provide opportunities for insight in both theory and practice.

Broad Scope of the Automatic Stay: This decision serves as a reminder that the scope of the automatic stay is extensive. It is widely understood that the protection of the automatic stay applies to Debtor’s property, but this decision highlights that § 362(a)(3) also includes “property of the estate.”  And property of the estate includes assets beyond the property of the Debtor. This distinction is important: the automatic stay safeguards not merely what the debtor owns, but everything legally belonging to the bankruptcy estate, regardless of who holds title. Further, in a twist, the automatic stay, which typically shields debtors, also protected the Trustee’s interests against the Debtor’s actions, resulting in the Debtor being sanctioned for violating a legal protection that is usually seen as a shield for debtors.

Intangible and Fractional Property Interests: The court reaffirms that “property” is not confined to tangible assets or whole ownership stakes. Even fractional interests – such as Debtor’s 50% interest in Life Capital – and intangible “bundles of rights,” such as the Trustee’s claims, fall under the stay’s protection. This principle is illustrated through a useful analogy: if an estate asserts a mere 0.1% interest in the stock of GM, without directly challenging property held by the company, it would not constitute a stay violation. However, actions seeking to control or seize even a small portion of the estate’s interests are subject to the automatic stay. This concept mirrors the court’s holding in Klein, where the 50% membership interest—though not full ownership—was deemed sufficient to trigger the automatic stay. Even a fractional stake in the estate’s assets is protected, reinforcing the stay’s broad scope. Practitioners must recognize that even minor estate interests, such as claims or fractional ownership, are shielded by the stay.

Implications for Fractional Interests and Contemporary Property Types: The Bialac test’s emphasis on the alteration of property interests serves as a reminder that even fractional stakes in an estate, such as the 50% membership interest in Life Capital, can trigger the automatic stay’s protection. This principle resonates with the current debate surrounding accessory dwelling units (ADUs), where courts are grappling with the homestead exemption and, if applicable, the stay’s application to these increasingly common property types and a debtor’s fractional interest in the buildings on his land.

Sanctions for Stay Violations: While the Supreme Court established the “objectively reasonable basis” standard in Taggart for discharge violations, this decision notably applies that standard to an automatic stay violation. Historically, the Ninth Circuit has handled stay violations through adversary proceedings (or Motion for OSC re: Sanctions) rather than the contempt proceedings typical for discharge violations. Furthermore, Ninth Circuit precedent does not extend the Taggart “reasonable belief” test specifically to stay violations. Although the court found Respondents lacked such a basis for their actions, practitioners should note that applying this standard to stay violations could conflict with established Ninth Circuit procedures.

Strategic Litigation Tactics: Related, the court condemned Respondents’ “race to the courthouse” – their calculated effort to establish a claim in state court immediately after the Trustee initiated the adversary proceeding. This was not an isolated incident; the court noted Respondents had previously employed the same tactic, receiving a warning from the bench. By filing state court actions immediately after the Trustee’s adversary proceeding, respondents attempted to “alter” the estate’s bundle of rights—a key element of the Bialac test. This pattern of conduct, as the court noted, reflects a systemic effort to circumvent the stay rather than seek relief from it. The court disapproved this pattern of strategic circumvention, signaling that it will closely scrutinize such behavior and apply sanctions where warranted. The court’s disapproval of this tactic signals a shift toward proactive enforcement. Parties must now weigh the risk of sanctions against the potential benefits of parallel litigation, and be aware that good faith matters, while repeated attempts to bypass the bankruptcy process will be met with judicial disapproval.

Permission is Better than Seeking Forgiveness: Perhaps the biggest takeaway of all is that if there is any chance an action – even one taken with good cause or justification – may violate the stay, the party would be wise to first file a motion for relief. This case demonstrates that the automatic stay is a powerful shield, and those who attempt to pierce it without permission do so at their own risk. The court clearly signaled its intention to scrutinize attempts to circumvent its authority and that it would closely examine the motives of those who engage in such tactics. In the realm of bankruptcy, a proactive request for relief is far preferable to a reactive reckoning with the consequences of a violation.

While In re Klein provides valuable insights into the scope and application of the automatic stay, practitioners should remain cognizant of the procedural nuances and potential precedent issues raised by the court’s analysis, particularly regarding the applicability of the Taggart standard to automatic stay violations under Ninth Circuit law.

These materials were written by Hale Andrew Antico, Chief Counsel of Antico Law Firm, representing consumer debtors in the Central District of California, and President of the Central District Consumer Bankruptcy Attorneys Association, with editorial contributions by Kathleen A. Cashman-Kramer, a director with Fennemore LLP’s San Diego office, and the Hon. (ret.) Meredith Jury.