The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, analyzing a recent decision of interest:
In Garcia v. Sklar (In re Sklar), ___ B.R. ___, 2021 WL 1537015 (Bank. S.D.N.Y., April 20, 2021)) (“Sklar”), the United States Bankruptcy Court for the Southern District of New York (the “Court”) rejected a creditor’s request for retroactive stay relief but granted her stay relief to re-file and prosecute a lawsuit (the “Action”) in the District Court alleging discrimination, sexual harassment and related claims that she had filed against the debtor during the debtor’s abortive prior bankruptcy case and in which she had obtained a default judgment. The Court saved for later determination whether she knew about the first bankruptcy before she obtained the judgment.
Sklar can be found here.
The creditor worked for the debtor and his companies. The debtor filed a chapter 11 case (the “First Case”) in August, 2017. Just over a year later, the Court dismissed the First Case because of the debtor’s failure to prosecute it and other defaults. In the intervening months, the creditor filed the Action against the debtor and his companies. After all the defendants defaulted, the debtor obtained a default judgment and the District Court referred the matter to a magistrate judge for determination of damages. The debtor never brought any of this to the Court’s attention during the First Case by his Schedules, Statement of Financial Affairs (“SOFA”) or any other means.
In May 2019, Sklar filed a second Chapter 11 case (the “Second Case” and together with the First Case, the “Bankruptcy Cases”) before the same judge. Again, the debtor did not advise the Court of the debtor’s claim, the Action or any of its proceeding in his initial filings of his Schedules, his SOFA or any other papers. The Court eventually converted the case to a Chapter 7. The claims bar date was in early December 2019, and the discharge objection deadline was in mid-December.
In November 2109, the magistrate judge issued a report and recommendation (the “RR”) to the District Court of just under $300,000 in damages. In early 2020, after passage of the clams bar date and discharge/dischargeability objection deadlines in the Second Case, the District Court adopted the RR and entered judgment for the creditor. Up until this point, the District Court had no notice of the First Case or Second Case. Eventually, the creditor filed an adversary proceeding (the “AP”) objecting to the debtor’s discharge and the dischargeability of her claim on various grounds under Bankruptcy Code (the “Code”) §§ 523 and 727, including Code § 523(a)(6) (“willful and malicious injury”). Only after this development did the debtor finally list the Action in an amended SOFA. In the course of subsequent proceedings, the creditor also filed a motion for retroactive stay relief to validate all that had occurred in the Action, again essentially on the grounds of lack of timely notice of the Bankruptcy Cases. However, at no time did the creditor actually offer any evidence on the notice issue. By the same token, the debtor never asserted that he did not know about the Action in time to respond to it, although he did argue that the creditor had notice of the Bankruptcy Cases. These two proceedings generated various further filings by the parties. It is fair to say that neither counsel handled the matters skillfully, either procedurally or substantively, occasioning a complex record not worth recounting in this report.
Ultimately, the Court denied the creditor retroactive stay relief, permitted her to refile the Action to liquidate her claim and retained control of the AP, also reserving determination of when the creditor learned of the Bankruptcy Cases.
The Court ruled that under Second Circuit law, all the proceedings in the Action were void ab initio, not merely voidable (as some other courts hold), because they violated the automatic stay of Code section 362(a); whether the creditor knew of the Bankruptcy Cases is irrelevant. Church Mut. Ins. Co. v. Am. Home Assur. Co. (In re Heating Oil Partners, LP), 422 F. Appx. 15, 18 (2d Cir. 2011); Rexnord Holdings, Inc. v. Bidermann, 21 F.3d 522, 527 (2d Cir. 1994). However, it noted the validity of the Action as against the other defendants was not at issue because the stay does not protect them, so for whatever it was worth the District Court judgment against them stood.
Next the Court considered whether to grant the creditor stay relief retroactively to validate the proceedings in the Action, an outcome permissible in the Second Circuit under E. Refractories Co. v. Forty Eight Insulations, 157 F.3d 169, 172 (2d Cir. 1998). This requires stay relief “for cause” under Code section 362(d)(1). The moving party has the burden of making a prima facie case for cause, after which the debtor has the burden of proof. On the issue of retroactive stay relief, , the Court applied certain of the seven factors of In re Stockwell, 262 B.R. 275, 281 (Bankr. D. Vt. 2001), which it said are widely used in the Second Circuit for the specific question of retroactive stay relief. While some of the factors favored the creditor, other did not, or at least not materially. For example, it found that although it probably would have granted the creditor stay relief in the First Case had the issue come up, the additional burden on the creditor of having to re-do the liability and damages proceedings either in the Second Case or District Court was tolerable since the creditor’s efforts had been simplified by the default that the debtor was entitled to suffer while protected by the stay. On balance, it found for the debtor.
However, the Court next considered whether to grant the creditor prospective stay relief to liquidate its claim in the District Court by refiling the Action (evidently this choice did not present a statute of limitations issue, or at least none is discussed in Sklar). It reasoned that because the proceedings in the Action were void ab initio, stay relief would have to be prospective so that the creditor could begin the Action anew. Here the Court reverted to the twelve criteria for stay relief “for cause” found in In re Sonnax Indus., 907 F.2d 1280, 1285 (2d Cir. 1990) that the facts implicated. Factors in the Court’s ruling included that as the creditor’s claims in the Action included personal injury claims, at least part of her allegations would have to be tried in the District Court under 28 U.S.C. § 157(b)(5) anyhow. For that reason, to have to resolve all her claims in the District Court did not represent a material incremental burden on the debtor (indeed, proceeding in one court rather than two probably would be less expensive). Similarly, and for like reasons, the Court also concluded that litigation in the District Court would not interfere with the Second Case or harm the debtor’s other creditors.
However, the Court retained jurisdiction over the issues of the AP. It found that some of the claims the creditor made in the AP were irrelevant to §§ 523 and 727, Of the remainder, the deadline to object to dischargeability under Code § 523(a)(6) and any of the discharge provisions of Code § 727 had expired. However, there is no such deadline for claims under Code § 523(a)(3) for unlisted or unscheduled claims. Thus, the Court granted the creditor stay relief to liquidate her claims in the District Court as a prelude to deciding itself whether the claims were not dischargeable under § 523(a)(3). For the latter, the Court granted the creditor leave to amend the AP to allege a cause of action under § 523(a)(3), which the original complaint did not assert. The resolution of that claim, in turn would depend in part on determination by the Court at the appropriate time of whether the creditor had knowledge of the Second Case in time to file her proofs of claim.
A reading of Sklar suggests that the debtor abused the bankruptcy process and was not an attractive character. That may explain why the Court in trying to apply the law systematically worked so hard to find a narrow way forward for the creditor. Indicative of the Court’s apparent attitude are its offering the creditor leave to amend the AP to follow the route the Court mapped for her while letting her know that it was not giving her a free pass by prominently reserving the question of whether she had timely notice of the Bankruptcy Cases. Similarly, the Court switched from retroactive to prospective stay relief for the creditor’s benefit even though it does not appear she plead that in her stay relief motion. What also is notable about Sklar is the Court’s willingness to overlook the procedural mishaps of the parties in order to produce a result. In the author’s opinion that speaks of a court trying to serve the public without tolerating outright incompetence or misbehavior.
These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, 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.