In a 16 page opinion released January 28, 2016 in the Casino Caribbean, et al. v. Money Centers of America adversary proceeding (Bank. D. Del. Adv. No. 14-50437), Judge Christopher S. Sontchi of the Delaware Bankruptcy Court granted the motion of Quapaw Casino to intervene in the adversary proceeding.  Judge Sontchi’s opinion is available here (the “Opinion”).

Plaintiffs in the adversary proceeding had obtained a court order requiring the Debtors’ to maintain a cash balance of $900,000 or more, in order to compensate the Plaintiffs if it should be determined that the Debtors were holding funds as a ‘mere conduit’ to which the Plaintiffs were entitled.  Opinion at *2.  Quapaw claimed that the Debtors were likewise holding funds to which it was entitled, and moved to intervene in the adversary proceeding, in order to obtain the same relief.  Plaintiffs opposed the motion, fearing that the set-aside funds would be insufficient to compensate them and Quapaw.  Opinion at *2.

The Debtors had entered into an agreement with Quapaw to provide ATM and other cash advance services to Quapaw’s customers, and that any funds advanced to a customer by Quapaw would be reimbursed by the Debtors.  Quapaw is listed on the Debtors’ schedules and filed a proof of claim for $502,018.  Opinion at *4.

The adversary complaint was filed on July 7, 2014.  Quapaw filed its motion to intervene on January 21, 2015.  As of that time, the Debtors had not yet filed an answer in the adversary proceeding.  Pursuant to Fed. R. Civ. P. 24(a) “A movant has an unconditional right to intervene when its motion is timely filed and either (A) a federal statute grants an unconditional right to intervene or (B) the movant claims an interest that is related to the property or transaction that is the subject of the adversary proceeding and disposing of the proceeding impairs or impedes the movant’s ability to protect its interest as a practical matter, unless the parties adequately represent that interest.”  Opinion at *7.  Ultimately, Judge Sontchi found that Quapaw satisfied this requirement.  Opinion at *8.

Judge Sontchi then examined the case under the permissive intervention standard of Fed. R. Civ. P. 24(b), finding that Quapaw also satisfied those requirements.  Opinion at *16.

As this Opinion illustrates, it is difficult to prevent another party from following the path you create and obtaining the same relief, when their claims are practically identical to your own.  In cases like this one, where a finite quantity of funds are available, it may be worth your time to investigate whether your relief would be diminished if another party received identical treatment.  If it would, then you may want to spend a bit more time investigating whether those similarly situated parties exist and take them into account in the relief you seek.

The Court held that QCA had a right to intervene under both Fed. R. Civ. P. 24(a)(1) and (a)(2), and that permissive intervention was warranted under Fed. R. Civ. P. 24(b)(1)(B).  Rule 24(a) has 4 requirements,

Very often in the course of a bankruptcy proceeding, a creditor with a pending lawsuit against the debtor will need to obtain relief from the automatic stay in order to continue to prosecute the pre-petition litigation.   For example, personal injury claimants who seek to recover solely against an insurance policy of a debtor may obtain relief from the automatic stay in certain circumstances.  Such claimants will need to file a motion with the Delaware Bankruptcy Court to obtain relief from the stay in order to pursue their claim to a final judgment.

Relief from Stay

Under section 362(d)(1) of the Bankruptcy Code, the bankruptcy court “shall” lift the automatic stay for “cause.”  If a creditor seeking relief from the automatic stay makes a prima facie case of “cause” for lifting the stay, the burden going forward shifts to the debtor pursuant to Bankruptcy Code § 362(g). See In re 234-6 West 22nd St. Corp., 214 B.R. 751, 756 (Bankr.S.D.N.Y. 1997).

The Bankruptcy Code does not define “cause.” Instead, whether cause exists to lift the automatic stay should be determined on a case by case basis. See Izzarelli v. Rexene Prod. Co. (In re Rexene Prod. Co.), 141 B.R. 574, 576 (Bankr.D.Del. 1992). See also, In re Texas State Optical, Inc., 188 B.R. 552, 556 (Bankr. E.D.Tex. 1995) (finding that “cause” for modification of the automatic stay is “an intentionally broad and flexible concept that permits … [a] [b]ankruptcy [c]ourt, as a court of equity, to respond to inherently fact-sensitive situations.”) Courts determine what constitutes “cause” based on the totality of the circumstances in each particular case. Baldino v. Wilson (In re Wilson), 116 F.3d 87, 90 (3d Cir. 1997).

In re Rexene provides the “balancing test” to determine whether cause exists to lift the automatic stay. 141 B.R. at 576. Under Rexene, the balancing test looks at three factors to decide whether to lift the automatic stay, including: (a.) whether prejudice will be caused to the estate or the debtor;
(b.) whether hardship to the movant from continuing the stay outweighs any hardship to the debtor; and (c.) whether the movant has a reasonable probability of prevailing on the merits of the suit. Id.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In a 23 page opinion released July 21, 2015 in the Trump Entertainment Resorts case (Bank. D. Del. 14-12103), Judge Kevin Gross of the Delaware Bankruptcy Court opined upon the interaction of the Bankruptcy Code’s automatic stay and the Norris-LaGuardia Act (“NLA”).  Judge Gross’ opinion is available here (the “Opinion”).

We have previously posted about the Trump Bankruptcy and the conflict between the Debtors and UNITE HERE Local 54 (the “Union”) concerning the collective bargaining agreement (“CBA”):

Trump Entertainment Resorts Files for Chapter 11 Bankruptcy Protection in Delaware

Trump Entertainment – A Debtor’s Rejection of a Bargaining Agreement

As discussed in the prior post,  the Debtors were allowed to reject the CBA pursuant to Section 1113 of the Bankruptcy Code.  Around the same time as the Debtors were pursuing a rejection of the CBA, the Union began calling organizations and individuals who had scheduled events at the Taj Majal to inform them of the dispute the Union and Debtors had over the CBA.  Opinion *2-3.  The Debtors then filed the “Stay Motion” which is decided by the Opinion.  In the Stay Motion, the Debtors argue that the Union’s communication with Taj Mahal customers violated the automatic stay.  The Union objected to the Stay Motion, arguing that its communications were protected by the NLA.  Opinion at *5.

Judge Gross analyzed the NLA in detail, devoting pages 7-15 of the Opinion to the NLA and related case law.  The comments made during the House debate on the NLA proved quite informative:  “Gentlemen, there is one reason why this legislation is before Congress, and that one reason is disobedience of the law on the part of whom?  On the part of organized labor?  No.  Disobedience of the law on the part of a few Federal judges.”  Opinion *8, quoting 75 Cong. Rec. 5478 (1932).  The NLA was created in an effort to limit the power of Federal Judges, who had previously been seen as pro-management.

Judge Gross determined that “the dispute between the Union and the Debtors … qualifies as a labor dispute…” thus implicating the NLA to protect their communications.   Opinion *9.  However, “the Union’s protections under the NLA arguably run headlong into the Bankruptcy Code’s automatic stay…”  Opinion *10.  As Judge Gross opined, “if the statutes are read to cover the same conduct, application of the automatic stay will essentially work to repeal the NLA in the bankruptcy context.  It is incumbent upon the Court to adopt an interpretation that would, if possible, avoid such a result while giving effect to both statutes.”  Opinion at *14-15.  Judge Gross held that “the Court is duty-bound in this instance to select the interpretation which would give effect to both the automatic stay and the NLA….”  Opinion *22.  In this case, Judge Gross determined that the automatic stay of Section 362(a)(6) is inapplicable to the Union’s forward-looking labor activities, including their calls to potential clients in an effort to influence negotiations of a new collective bargaining agreement.

My $.02

In his opinion and ruling, Judge Gross “attempted to walk an interpretive tightrope to arrive at a construction of the automatic stay which would give effect to both the stay and the NLA.”  Opinion *22.  One of the responsibilities of the court is to interpret laws in such a manner as to avoid creating a conflict between them.  It behooves an attorney to try and help the court navigate the inconsistencies of a conflict in a manner that gives effect to all of the implicated statutes, rather than arguing for one statute to be revised or struck.  If one party to a conflict proposes an interpretation that allows both statutes to remain in effect and the other does not, the court will be more influenced by the interpretation that gives full effect to both statutes.

In an 19 page opinion issued April 1, 2015 in the SS Body Armor I, Inc. Bankruptcy (10-11255), Judge Sontchi held that an action to compel a shareholder meeting is not barred by the automatic stay of 11 U.S.C. 362.  The Opinion is Available Here.

Background

This case if full of drama; the Debtors’ former CEO was found guilty of fraud, and his brother is the shareholder who is pushing for the shareholders’ meeting to be held.  While the drama is addressed in the Opinion, it does not appear to affect the final ruling, so it won’t be addressed in this blog post.  The pertinent facts are simple:  SS Body Armor (the “Debtors”) filed for bankruptcy in April, 2010;  The Debtors last held a shareholder meeting in 2009.  The Movant (Jeffrey Brooks) is seeking a court order allowing him to commence an action in Chancery Court to force a shareholders’ meeting to occur.

The Opinion

The Movant argues that the automatic stay does not bar an action to compel a meeting of shareholders, and the Debtors agreed that, as a general ruled, shareholders have the right to compel a shareholders’ meeting.  Opinion at *11.  The Debtors add the caveat that in the event of “clear abuse” the shareholders lose that right.

The Court begins its analysis with the subject heading “The Automatic Stay Is Not Applicable to an Action in the Chancery Court to Summarily Order a Shareholder Meeting.”  Opinion at *12.  This heading summarizes the Court’s ruling in this case.  The Court cited to a number of cases in its decision, primarily Manville Corp. v. Equity Security Holders Committee (In re Johns-Manville Corp.), 801 F.2d 662 (2d Cir. 1935), In re Potter Instrument Co., 593 F.2d 470 (2d Cir. 1979), Official Bondholder Committee v. Chase Manhatten [sic] Bank (In re Marvel Entm’t Grp., Inc.), 209 B.R. 832 (D. Del. 1997), and Minter v. Directors of Concrete Products (Matter of Concrete Products, Inc.), 110 B.R. 997 (Bankr. S.D. Ga. 1989).

The Opinion adopts the holdings of Johns-Manville and Marvel Entertainment.  Opinion at *17.  Judge Sontchi held that the right of a shareholder to compel a shareholder’s meeting . . . continues during bankruptcy and the automatic stay is inapplicable.  Opinion at *17.  The Bankruptcy Court may, however, enjoin the shareholder meeting when there is a “clear abuse.”  Clear abuse is determined to occur when there is a showing of delay and real jeopardy to a debtor’s reorganization.  Opinion at *18.

While Judge Sontchi held that there is an argument that clear abuse is present in this case, Rule 7001 requires that a proceeding to obtain an injunction or other equitable relief is an adversary proceeding.  Opinion at *18.  Because the Debtors did not initiate an adversary proceeding to enjoin the Movant’s requested relief, their opposition was procedurally improper and the Motion would be granted.

My $.02

Bankruptcy Rule 7001 provides tight bounds around what relief can be requested in a main bankruptcy case.  When dealing with a Judge who has been known to require parties to strictly adhere to the Rules, it is best to keep in mind the mantra of many lawyers and act out of an “abundance of caution”.

The automatic stay is one of the most powerful protections provided to debtors in a bankruptcy proceeding.  The stay acts as an injunction that prohibits creditors (including landlords) from commencing or continuing any proceeding against the debtor which could have been commenced prior to the bankruptcy.  Applied to landlords, the automatic stay prohibits efforts to collect unpaid rent, or seek eviction, setoff, lease termination or foreclosure, among others.

It is important for landlords to realize that the automatic stay becomes effective without notice or a hearing.  Were a landlord (or any creditor) to be found in violation of the automatic stay, the debtor-tenant may be able to recover actual damages from the landlord, including attorneys’ fees.  If the violation is found to be intentional, the debtor-tenant may recover punitive damages.

In order to avoid the consequences resulting from violating the automatic stay,  landlords should seek relief from the stay by filing a motion with the bankruptcy court.  Under Section 362 of the Bankruptcy Code, creditors can seek relief from the automatic stay “for cause.” An example of “cause” includes the tenant’s failure to pay rent.

Carl D. Neff is a bankruptcy attorney with the law firm of Fox Rothschild LLP.  Carl is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

Summary

When a company files for bankruptcy, they gain a number of protections under federal law.  One of these protections is the “automatic stay” provided by 11 U.S.C. § 362. The automatic stay makes it illegal to continue prosecuting, or to initiate, an action against the debtor who is in bankruptcy.  Even if that debtor has injured you, it means that you cannot try to recover from them without getting the automatic stay lifted.  As more large bankruptcy cases are filed in Delaware, it becomes increasingly important that persons injured by debtors understand the legal hoops that they have to jump through in order to recover for their injuries.

To aid in discussing this matter, imagine a situation in which a person (the “Injured”) is injured when hit by a truck belonging to the company (the “Debtor”).  The Injured files a lawsuit in state court to recover and the Debtor files for bankruptcy protection in Bankruptcy Court for the District of Delaware (“DE Bankruptcy Court”).  The last important assumption is that the Debtor, like most large companies, has insurance that can compensate the Injured.  While many of the principles of this post will apply in other courts, it will be discussed specifically in the context of this purely hypothetical situation.

The Automatic Stay

11 U.S.C. § 362 (“Section 362”) provides that, with limited exceptions, when the Debtor files for bankruptcy, a stay is placed on actions that could otherwise be brought against it.  Section 362 includes prohibitions against nearly any legal action that could be brought against the Debtor in any court other than the DE Bankruptcy Court.  While there are exceptions, they are very specific and beyond the scope of this post.  Rather, this post will focus on what a person who was injured by a Debtor should do in order to obtain a recovery.

The specific provisions of Section 362(a) which relate to our example are as follows:
“[A] petition filed under … this title … operates as a stay … of –
(1) the commencement or continuation  … of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;
(3) 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;

Thus, the Injured will find it very difficult to recover, since they are prohibited from bringing a new lawsuit against the Debtor or continuing to prosecute the lawsuit that has already begun.  In some instances, a Debtor will declare bankruptcy days before a trial is scheduled to begin, freezing any litigation against it.  While this is certainly frustrating for the Injured, there is a path to obtain recovery.

Relief from the Automatic Stay

In order to resume an existing lawsuit against the Debtor, or start a new lawsuit against the Debtor, the Injured must obtain relief from the automatic stay.  This requires the Injured to file a motion for relief from stay and the judge presiding over the bankruptcy to grant the motion.

The relevant language from the Bankruptcy Code is found in Section 362(d), which provides in pertinent part as follows:
(d) On request of a party in interest and after notice and a hearing, the court shall grant relief from the stay provided under subsection (a) of this section, such as by terminating, annulling, modifying or conditioning such stay –
(1) for cause, including the lack of adequate protection of an interest in property of such party in interest.

Thus, the DE Bankruptcy Court is required to determine if there is “cause” to lift the stay.  In making that determination, the DE Bankruptcy Court follows the analysis of the case Izzarelli v. Rexene Prods. Co. (In re Rexene Prods. Co.), 141 B.R. 574, 577 (Bankr. D. Del. 1992).  The DE Bankruptcy Court places the initial burden on the Injured to establish that cause exists, and allows the Debtor an opportunity to rebut the Injured’s argument.

In the Rexene opinion, the DE Bankruptcy Court cites to the legislative history of Section 362 in its holding that ‘It will often be more appropriate to permit proceedings to continue in their place of origin, when no great prejudice to the bankruptcy estate would result, in order to leave the parties to their chosen forum and to relieve the bankruptcy court from any duties that may be handled elsewhere.’  Rexene Prods., 141 B.R. at 576 (quoting H.R. Rep. No. 95-595, 95th Cong., 1st Sess., 343-344 (1977)).

The DE Bankruptcy Court has adopted a three-prong analysis to determine whether there is cause to grant relief from the automatic stay.  The court determines whether (i) any great prejudice to either the bankruptcy estate or the Debtor will result from continuation of the civil suit; (ii) the hardship to the Injured by maintenance of the stay considerably outweighs the hardship to the Debtor; and (iii) the Injured has a probability of prevailing on the merits.

A bankruptcy estate generally is not considered to have an interest in proceeds of liability insurance policies.  Consequently, the DE Bankruptcy Court typically holds that a Debtor does not suffer prejudice or hardship if the Injured obtains stay relief to liquidate claims that are covered by such proceeds.

With respect to the third prong of the analysis regarding cause, the DE Bankruptcy Court held in Rexene that the required showing is very slight.  The threshold for this third prong is even easier to meet where a movant’s claim would be covered by non-debtor sources. In cases following Rexene, the DE Bankruptcy Court has stated that under such circumstances, a bankruptcy court should not examine the merits of the movant’s claims. Rather, “all that is required is that the movant make more than a ‘vague initial showing’ that he can establish a prima facie case. In a case, [sic] such as this one where the claimant seeks only to liquidate its claims as a predicate to recovering against insurance and other non-debtor sources, to require a merits analysis would defeat the objective of economizing judicial resources and would frustrate the effort to resolve relief from stay motions expeditiously.” Santa Fe Minerals v. BEPCO. L.P. (In re 15375 Memorial Corp.), 382 B.R. 652, 691 (Bankr. D. Del. 2008).

In deciding whether to lift the automatic stay, the Delaware Bankruptcy Court has also considered general policies, including: 1) whether relief would result in a partial or complete resolution of the issues; 2) lack of any connection with or interference with the bankruptcy case; 3) whether the debtor’s insurer has assumed full responsibility for defending it; 4) whether the parties are ready for trial in the other proceeding; and 5) impact of the stay on the parties and the balance of the harms.  While these issues may provide additional support for the motion for relief from stay that the Injured will need to file, the DE Bankruptcy Court will typically consider them within the context of the Rexene analysis, so attorneys for the Injured should always consider the Rexene factors first.

Finally, 28 U.S.C. § 157(b)(5) provides that Personal Injury and Wrongful Death claims shall be tried in the district court.  Thus, even if a bankruptcy court wanted to decide a personal injury matter, such a case cannot be tried in the bankruptcy court.  I have had the opportunity to observe, on multiple occasions, the judges of the Delaware Bankruptcy Court tell debtors’ counsel that they will not decide personal injury matters.  And while past performance is no guarantee of future results, it does provide a level of predictability here in Delaware.

Introduction

As more companies file for bankruptcy, creditors and other interested parties of a debtor must quickly familiarize themselves with the automatic stay.  Section 362(a)(1) of the Bankruptcy Code stays “the commencement or continuation … of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement” of a bankruptcy proceeding.  Generally speaking, the automatic stay is intended to give the debtor a “breathing spell” from its creditors.  To do so, the stay stops various forms of collection efforts against the debtor.

The automatic stay is not without limitations, however.  In drafting the Bankruptcy Code, Congress carved out exceptions where the automatic stay does not apply.  Further, the Federal Rules of Bankruptcy Procedure provide procedural safeguards for a party seeking relief from the automatic stay.  Given the frequency with which automatic stay issues arise in bankruptcy proceedings, this post is intended to provide a brief summary of the scope of the automatic stay.  Further, the latter part of this post looks at cases frequently cited by parties seeking relief from the automatic stay in the Delaware Bankruptcy Court.

Scope of the Automatic Stay

Section 362(a)(3) of the Bankruptcy Code defines the scope of the automatic stay.  Under this section, the automatic stay bars 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.”  In order to have the stay “lifted,”  section 362(d) authorizes a bankruptcy court to “grant relief from the stay provided
under subsection (a) of this section, such as by terminating, annulling, modifying or conditioning such stay …(1.) for cause, including the lack of adequate protection of an interest in property of such party in interest.”

In order to trigger the automatic stay, there must be an act against either the debtor or against property of the debtor or of the estate. The automatic stay does not stay actions taken against non-debtor third parties. The Third Circuit has recognized that although the automatic stay has a broad scope,  the clear language under 362(a) applies only against a debtor.  See McCartney v. Integra Nat’l Bank North, 106 F.3d 506, 509 (3d Cir. 1997).  As a consequence “it is universally acknowledged that an automatic stay of proceedings accorded by § 362 may not be invoked by entities such as sureties, guarantors, co-obligors, or others with a similar legal or factual nexus to the … debtor.”  Id.

Relief from Stay

Under section 362(d)(1) of the Bankruptcy Code, the bankruptcy court “shall” lift the automatic stay for “cause.”  If a creditor seeking relief from the automatic stay makes a prima facie case of “cause” for lifting the stay, the burden going forward shifts to the debtor pursuant to Bankruptcy Code § 362(g). See In re 234-6 West 22nd St. Corp., 214 B.R. 751, 756 (Bankr.S.D.N.Y. 1997).

The Bankruptcy Code does not define “cause.” Instead, whether cause exists to lift the automatic stay should be determined on a case by case basis. See Izzarelli v. Rexene Prod. Co. (In re Rexene Prod. Co.), 141 B.R. 574, 576 (Bankr.D.Del. 1992). See also, In re Texas State Optical, Inc., 188 B.R. 552, 556 (Bankr. E.D.Tex. 1995) (finding that “cause” for modification of the automatic stay is “an intentionally broad and flexible concept that permits … [a] [b]ankruptcy [c]ourt, as a court of equity, to respond to inherently fact-sensitive situations.”) Courts determine what constitutes “cause” based on the totality of the circumstances in each particular case. Baldino v. Wilson (In re Wilson), 116 F.3d 87, 90 (3d Cir. 1997).

In re Rexene provides the “balancing test” to determine whether cause exists to lift the automatic stay. 141 B.R. at 576. Under Rexene, the balancing test looks at three factors to decide whether to lift the automatic stay, including: (a.) whether prejudice will be caused to the estate or the debtor;
(b.) whether hardship to the movant from continuing the stay outweighs any hardship to the debtor; and (c.) whether the movant has a reasonable probability of prevailing on the merits of the suit. Id.

In addition to the factors outlined above, a bankruptcy court may also consider the following general policies when deciding whether to grant a motion to lift the stay. These policies include: (1) whether the court has jurisdiction to hear the underlying claims arising from the underlying action; (2) whether granting movant relief from stay would provide a complete resolution of the issues presented in the underlying action; (3) whether granting the movant relief from the automatic stay would interfere with the debtors’ bankruptcy proceeding; (4) whether the interest of judicial economy and the expeditious and economical resolution of litigation weigh in favor of granting the movant relief from the automatic stay; (5) whether the parties are ready for trial in the underlying action; and, (6) whether the impact the stay has on the movant justifies the relief requested in the motion. In re: SCO Group, Inc., 395 B.R. 852, 857-58 & 859 (Bankr. D. Del. 2007).

Conclusion

Bankruptcy courts consider many factors when deciding whether to lift the automatic stay.  The broad scope of issues that can be considered by the court illustrate the flexibility provided for under the Bankruptcy Code.  Aside from the factors above, the timing of the request to lift the stay (i.e. requesting relief from stay days versus months after the commencement of a bankruptcy proceeding) also plays an important role in whether a court decides to lift the automatic stay.  A future post on this blog will look at recent decisions addressing the automatic stay.

Introduction

The Fairchild Corporation (“Fairchild” or the “Debtor”), filed for bankruptcy in Delaware on March 18, 2009.  Fairchild’s bankruptcy proceeding is before the Honorable Christopher S. Sontchi of the United States Bankruptcy Court for the District of Delaware.  According to its press release, Fairchild operates in three markets:  aerospace, real estate and motor cycle apparel.  In the aerospace industry, Fairchild distributes parts and equipment to companies servicing aircraft.  Fairchild’s business also includes managing and developing commercial real estate.  Finally,  with its apparel business, Fairchild designs and produces motorcycle apparel for companies such as Harley Davidson and PoloExpress.  (Read Fairchild’s Affidavit in Support of Bankruptcy Motions here.)

The DIP Financing Motion and Relief From the Automatic Stay

One of Fairchild’s “first day” motions seeks debtor-in-possession (“DIP”) financing, refinancing of prepetition debt and modification of  the automatic stay (the “DIP Motion“).  As stated in the DIP Motion,  Fairchild’s prepetition debt totals $19 million and Fairchild seeks to refinance its debt with a postpetition revolving credit facility up to $23 million (the “DIP Facility”).  Under the DIP Facility, PNC, as postpetition lender, would receive a “priming lien” that is senior or equal to previously encumbered property.  Fairchild seeks the priming lien for the DIP Facility pursuant to 11 U.S.C. 364(d)(1)(authorizing a bankruptcy court to approve DIP financing secured by an equal or superior lien on property of the estate already subject to a lien, provided the holder of the primed lien receives adequate protection).

Pursuant to paragraph 65 of the DIP Motion, Fairchild proposes that the automatic stay under 11 U.S.C. 362 be vacated to permit the DIP lenders to perform “any acts necessary to implement” the DIP Facility.  In addition, Fairchild seeks to lift the automatic stay for the lenders “to the extent necessary to exercise, upon the occurrence and during the continuation of any event of default … and to take various actions without further order of or application to the Court.”  Although the DIP Motion does not contain citations for granting relief from the automatic stay, it notes that “[s]tay modification provisions of this sort are ordinary and usual features of debtor in possession financing.”  This blog post will look at the standard often applied in Delaware for parties seeking relief from the automatic stay.

Scope of the Automatic Stay

Section 362(a)(3) of the Bankruptcy Code defines the scope of the automatic stay.  Under this section, the automatic stay bars 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.”  In order to have the stay “lifted,”  section 362(d) authorizes a bankruptcy court to “grant relief from the stay provided
under subsection (a) of this section, such as by terminating, annulling, modifying or conditioning such stay …(1.) for cause, including the lack of adequate protection of an interest in property of such party in interest.”

In order to trigger the automatic stay, there must be an act against either the debtor or against property of the debtor or of the estate. The automatic stay does not stay actions taken against non-debtor third parties. The Third Circuit has recognized that although the automatic stay has a broad scope,  the clear language under 362(a) applies only against a debtor.  See McCartney v. Integra Nat’l Bank North, 106 F.3d 506, 509 (3d Cir. 1997).  As a consequence “it is universally acknowledged that an automatic stay of proceedings accorded by § 362 may not be invoked by entities such as sureties, guarantors, co-obligors, or others with a similar legal or factual nexus to the … debtor.”  Id.

Relief from Stay

Under section 362(d)(1) of the Bankruptcy Code, the bankruptcy court “shall” lift the automatic stay for “cause.”  If a creditor seeking relief from the automatic stay makes a prima facie case of “cause” for lifting the stay, the burden going forward shifts to the debtor pursuant to Bankruptcy Code § 362(g). See In re 234-6 West 22nd St. Corp., 214 B.R. 751, 756 (Bankr.S.D.N.Y. 1997).

The Bankruptcy Code does not define “cause.” Instead, whether cause exists to lift the automatic stay should be determined on a case by case basis. See Izzarelli v. Rexene Prod. Co. (In re Rexene Prod. Co.), 141 B.R. 574, 576 (Bankr.D.Del. 1992). See also, In re Texas State Optical, Inc., 188 B.R. 552, 556 (Bankr. E.D.Tex. 1995) (finding that “cause” for modification of the automatic stay is “an intentionally broad and flexible concept that permits … [a] [b]ankruptcy [c]ourt, as a court of equity, to respond to inherently fact-sensitive situations.”) Courts determine what constitutes “cause” based on the totality of the circumstances in each particular case. Baldino v. Wilson (In re Wilson), 116 F.3d 87, 90 (3d Cir. 1997).

In re Rexene provides the “balancing test” to determine whether cause exists to lift the automatic stay. 141 B.R. at 576. Under Rexene, the balancing test looks at three factors to decide whether to lift the automatic stay, including: (a.) whether prejudice will be caused to the estate or the debtor;
(b.) whether hardship to the movant from continuing the stay outweighs any hardship to the debtor; and (c.) whether the movant has a reasonable probability of prevailing on the merits of the suit. Id.

Conclusion

The relief from stay sought for the DIP lenders in the Fairchild DIP Motion serves as one example of the importance of the automatic stay.  Through the DIP Motion, Fairchild seeks to preemptively lift the automatic stay so its lenders can exercise their rights in the event of a default.  Without receiving such blanket protection, lenders may be unwilling to lend to a debtor in possession.  Regardless, the automatic stay is a fundamental protection provided to debtors.  It is always helpful to understand the scope of the stay, as well as the parameters applied when a party seeks relief from the automatic stay.

Earlier this year, the United States Bankruptcy Court for the District of Delaware issued an important decision in American Home Mortgage, Inc. regarding the scope of the recently amended definition of a “repurchase agreement”.  Under the Bankruptcy Abuse Prevention Consumer Protection Act of 2005,  Congress broadened the Bankruptcy Code’s definition of  "repurchase agreement" to include the transfer of "mortgage related securities, mortgage loans [and] interests in mortgage related securities or mortgage loans."  A review of the opinion in Calyon New York Branch v. American Home Mortgage Corp., 379 B.R. 503 (Bankr.D.Del. 2008) provides guidance regarding how courts apply the revised definition going forward.  Furthermore, given the increase in mortgage related bankruptcies, Judge Christopher S. Sontchi’s decison In American Home Mortgage, Inc. addresses an important issue which is likely to arise again in future bankruptcy proceedings.

American Home Mortgage originated, sold and serviced subprime loans. Prior to filing for bankruptcy, Calyon New York Branch issued a notice of default to American Home, demanding that it repurchase the loans in Calyon’s possession. Soon after American Home filed for bankruptcy, Calyon sought a declaratory judgment finding that the agreement between the parties was a “repurchase agreement” as defined under the Bankruptcy Code.  Calyon also asked the court to find that the entire contract was a repurchase agreement, including the portion of the agreement governing loan servicing.

The court agreed with Calyon that the terms of the agreement rendered it a “repurchase agreement,” however, the court rejected Calyon’s argument that the loan servicing portion was a repurchase agreement. The court based its decision on the plain meaning of the contract. Applying the definition of “repurchase agreement” to the terms of the contract, the court found that American Home Mortgage agreed to transfer the originated loans to Calyon in exchange for funds, Calyon agreed to transfer the loans back to American Home Mortgage, also for funds, and the second transfer by Calyon was made within 180 days of the first.

By finding that the parties entered into a repurchase agreement, Calyon could proceed with its rights under the contract despite the automatic stay’s injunction against actions arising from a pre-bankruptcy default. However, Calyon did not receive such “safe harbor” protection for the loan servicing portion of the contract. Instead, the court found that the servicing component was an asset of American Home Mortgage that could be severed from the repurchase portion of the agreement.

In order to find that loan servicing could be severed from the repurchase agreement, the court considered several factors, most important of which was the language of the agreement. The loans were sold on a “servicing retained” basis, instead of “servicing released.” Had the parties intended to transfer the servicing rights to Calyon, the loan would have been structured as a servicing released agreement, resulting in Calyon paying a higher premium for the loans.

American Home Mortgage sheds light on how parties to a loan repurchase agreement can receive the protections provided under the Bankruptcy Code by satisfying the Code’s definition of “repurchase agreement.” It is the language of the agreement, not the economics of the transaction, that determine whether a contract is a repurchase agreement. Additionally, whether the servicing portion of the contract remains with the loan originator, versus the loan purchaser, also depends on the terms of the contract. By clarifying what constitutes a repurchase agreement under the Bankruptcy Code, American Home Mortgage provides guidance and certainty to parties drafting repurchase agreements, or those seeking to enforce their rights under an agreement with a lender in bankruptcy.