The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, analyzing a recent decision of interest:
In Censo, LLC v. New Rez, LLC, 2022 WL 1055936 (No. NV-21-1125-LTF) (9th Cir. BAP April 5, 2022)(“Censo”), the United States Bankruptcy Appellate Panel for the Ninth Circuit (the “BAP”) ruled that the post-petition entry of a judgment against the plaintiff debtor on a defendant’s counterclaims in a District Court quiet title claim action initiated by the debtor against the defendant did not violate the automatic stay.
Censo can be found here.
The procedural history of the matter is a bit convoluted, but the essentials are as follow. Pengilly borrowed money from a lender secured by a first trust deed on some property. He defaulted on his homeowner’s association (“HOA”) dues. The HOA foreclosed. An affiliate of the debtor purchased the property at the foreclosure and ultimately transferred it to the debtor. Pengilly sued the HOA and the debtor in state court, claiming that he still had title to the property because the foreclosure was flawed. The debtor counter claimed against Pengilly regarding the foreclosure, joining as defendants the lender and the servicer on the original Pengilly loan, asserting that the HOA foreclosure wiped out the lender’s lien. The servicer counterclaimed against the debtor, contending that the lien was valid. The case was removed to the District Court. The debtor and the servicer brought cross summary judgment motions there. The debtor subsequently filed its Chapter 11 bankruptcy. Not long after, the District Court granted summary judgment for the servicer, denied the debtor’s summary judgment motion and entered judgment (the “Judgment”) for the servicer against the debtor, ruling that the lender’s lien was valid.
The servicer then moved for and obtained stay relief in the Bankruptcy Court to foreclose on the lien. In the meantime, the debtor brought an adversary proceeding in the Bankruptcy Court against the lender and servicer to disallow the lender’s claim as based on an invalid lien due to alleged defects in the trust deed. The servicer responded that the debtor’s claims were barred by claim preclusion arising from the Judgment in the District Court and that, in any case, its lien title was not defective. The Bankruptcy Court sustained the servicer’s claim preclusion and lien validity defenses. On the former, it rejected the debtor’s challenge that certain of the elements of claim preclusion were absent. The debtor appealed to the Court. In that appeal, it raised for the first time the theory that the Judgment could not provide claim preclusion because as a postpetition judicial act it violated various provisions of the automatic stay of Bankruptcy Code section 362(a). Rejecting the debtor’s theories, the Court affirmed the Bankruptcy Court.
The Court focused principally on the stay issue (although it also rejected the debtor’s contention the criteria for claim preclusion were unsatisfied). In deciding the stay issue, it noted that it would be justified in ignoring that question altogether because the debtor had not raised it below. However, it nevertheless could consider it because it was purely a matter of law, requiring no development of facts that should have taken place had the debtor raised the issue in the Bankruptcy Court. Also, its willingness to the consider the question was not prejudicial to the servicer because if the servicer lost it could always move retroactively for stay relief.
The Court made several points related to the provisions of section 362(a) that the debtor invoked. It explained that in essence the servicer’s claim preclusive counterclaim was not an affirmative claim for relief against the debtor, but an affirmative defense to the debtor’s claims against it. The stay only stays actions against the debtor, not actions brought by the debtor. The District Court’s decision amounted to a judgment against the debtor on the debtor’s claims against the servicer, characterizing the servicer’s counterclaim as simply the “mirror” of the debtor’s affirmative claims. As well, the claim preclusion defense did not undermine the stay’s purpose of preserving the estate because it simply preserved the status quo as of the filing of the bankruptcy case by upholding a lien of record when the debtor filed the bankruptcy. By the same token, the stay not only protects the debtor, but also benefits creditors by preserving the estate for their benefit. The judgment did not diminish the estate; rather, it prevented an augmentation of the estate by denying the debtor’s attempt to invalidate the lien.
The outcome is neither puzzling nor controversial. The Court’s focus on the polices underlying the stay and how the Judgment was consistent with them was right on point. What is puzzling is why the debtor failed to challenge postpetition entry of the Judgment at three junctures: in the District Court before or immediately after it was entered, separately in the Bankruptcy Court or in the adversary proceeding. In its opinion, the BAP covered all the bases, even ones it could legitimately have skipped, both as protection in case of further appeals and, one suspects, as a device to discourage more afterthoughts by the debtor.
One point perhaps worth noting is that the Court’s statement that by considering the late-raised stay issue it did not prejudice the servicer because it if lost the latter the servicer could always seek stay relief retroactively is a bit disingenuous. Winning outright on the claim preclusion theory is better for the servicer than taking its chances on retroactive stay relief.
These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.