Willful Stay Violations Not Always Compensable

By Pepper Hamilton LLP

Sep 25, 2012

[authors: Francis J. Lawall and Erik L. Coccia]

The automatic stay arguably represents the most powerful tool available to a debtor seeking a fresh start through bankruptcy. Not surprisingly, therefore, courts tend to strictly enforce the stay and will often impose penalties, particularly under circumstances where the stay violation was intentional. For that reason, a recent U.S. Court of the Appeals for the Tenth Circuit opinion presents an interesting counterpoint by concluding that a willful violation of the automatic stay did not require the imposition of damages under circumstances where it would be fruitless to do so and contrary to the overall purposes of the Bankruptcy Code. (See Rushton v. Bank of Utah (In re C.W. Mining Co.), Ch. 7 Case Bankr. No. 08-20105, Adv. No. 10-02712, 2012 Bankr. LEXIS 4114 (B.A.P. 10th Cir. Sept. 5, 2012).)

In C.W. Mining Co., a bank provided financing to a debtor coal company that was secured by the debtor's equipment and a $362,000 certificate of deposit. After the debtor was involuntarily placed into Chapter 7, the bank liquidated the CD in partial satisfaction of its claims and then sold the balance of the loan to a third party. The bank was apparently aware of the debtor's pending bankruptcy resulting in the Bankruptcy Appellate Panel's conclusion that the stay violation was willful.

The Chapter 7 trustee filed a complaint against the bank seeking to avoid the transfer of the CD, recover its value and strip the bank's lien upon such recovery. The trustee argued that the bank's actions amounted to an unauthorized and reversible post-petition transfer pursuant to 11 U.S.C. § 549 and 11 U.S.C. § 550. He also asserted that liquidation of the CD violated the automatic stay under Section 362, thus requiring that the proceeds be turned over to the bankruptcy estate pursuant to 11 U.S.C. § 542.

With respect to the trustee's claims under Sections 549 and 550, the bank responded that relief was unwarranted because the estate would not benefit since it would remain a secured creditor even if the transfer was unwound. As for the trustee's stay violation and turnover claims under Sections 362 and 542, the bank argued that lien stripping as a remedy did not exist under these code sections, and moreover, were punitive and unwarranted since the bankruptcy estate suffered no damages.

The BAP affirmed the bankruptcy court's entry of summary judgment in favor of the bank, finding the bankruptcy court's pragmatic approach, focusing on whether or not the requested relief would actually benefit the bankruptcy estate, instead of whether or not the conduct at issue deserved remediation and/or punishment, to be persuasive.

The BAP first analyzed the trustee's claims under Sections 549 and 550 — succinctly summarizing those Bankruptcy Code sections as follows: "§ 549 allows a trustee to avoid a post-petition transfer, § 550 contains the statutory mechanism to recover the asset transferred or, as in this case, its value." Fatal to the trustee's claim was the panel's conclusion that Sections 549 and 550 must be viewed along with the Bankruptcy Code's "comprehensive process for avoidance, recovery and protection of a transferee's claim priority and status." Specifically, the trustee failed to appreciate the import of Section 502(h) which provides in relevant part: "A claim arising from the recovery of property under Section 522, 550, or 533 ... shall be determined, and shall be allowed ... the same as if such claim had arisen before the ... petition." The BAP concluded that the plain language of Section 502(h) entitles a creditor whose post-petition transfer has been avoided under Sections 549 or 550 to file a proof of claim for the amount of the transfer. The panel also found itself rigidly bound by the text of Section 502(h) pursuant to the plain meaning rule: "If [the statute] is clear on its face, the sole function of the court is to enforce it according to its terms." Indeed, as the BAP noted, numerous courts, including the Tenth Circuit, have previously concluded that voiding a post-petition transfer by a secured creditor was fruitless, as "the creditor's lien would necessarily be revived and the creditor would be restored to its secured status under § 502(h)." (See, e.g., In re ASI Reactivation Inc., 934 F.2d 1315, 1321 (4th Cir. 1991); Lowe v. Sheinfeld, Maley & Kay, P.C. (In re Saunders), 155 B.R. 405, 414 (Bankr. W.D. Tex. 1993), rev'd on other grounds, 96 F.3d 1444 (5th Cir. 1996).)

The BAP also highlighted the plain language of Section 550, which permits recovery of a post-petition transfer only if it will result "in some benefit to the bankruptcy estate." Given the revival of the bank's liens under Section 502(h), relief under Section 550 would be unwarranted because "there would be no benefit to the estate." To the contrary, returning the asset to the estate would actually devalue the estate by increasing administrative fees due to the trustee.

The trustee attempted to circumvent this reasoning by arguing that the bank's liens would not be restored following avoidance of the transfer because it sold the underlying loan to a third party. Relying on an Idaho bankruptcy court decision, Hopkins v. Suntrust Mortgage Inc. (In re Ellis), 441 B.R. 656, 667 (Bankr. D. Idaho 2010), which declined to revive a creditor's lien under similar circumstances, the trustee reasoned that the court could not "favor the interests of a wrong-doing transferee over those of the other creditors." The BAP rejected the Hopkins court's policy approach as ignoring the plain meaning of Section 502(h), which requires a court to determine claim status as if it had arisen pre-petition (here the bank sold its liens post-petition). (See Fleet Nat'l Bank v. Gray (In re Bankvest Capital Corp.), 375 F.3d 51, 68-69 (1st Cir. 2004).)

Regarding the stay violation claims, the BAP noted that "actions taken in violation of the automatic stay are void ab initio." Yet, it refused to void the bank's liens, finding that such relief would be an unauthorized penalty and simply illogical in light of prevailing law because Section 362 "does not extinguish or discharge any debt" and, moreover, the remedy for a stay violation is to restore both parties to the status quo. Additionally, the panel found that Section 362(k), the penalty provision within Section 362, only permits "individuals," not artificial entities such as trustees, to recover stay violation damages. Finally, the BAP denied relief under Section 542, reasoning that such code section does not require turnover if the "property is 'of inconsequential value or benefit to the estate.'"

The Tenth Circuit's ruling in C.W. Mining Co. reflects a pragmatic and arguably creditor friendly view of how to analyze and penalize stay violations. Here, notwithstanding a clear and intentional violation of the automatic stay, the panel went to great lengths to find that in the absence of harm to the estate and no benefit to be derived from unwinding the transfer, there was no penalty to be imposed. Whether and how far other courts will follow this path remains an interesting question.