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Bankruptcy Court Applies Automatic Stay to Continuation of Removed State-Court Action Against Debtor

When a debtor files for bankruptcy, almost all proceedings to recover property from the debtor are automatically stayed by force of law. See 11 U.S.C. § 362(a). This provision, known as the automatic stay, is a central feature of the bankruptcy process, but uncertainty remains about aspects of its scope. Last month, we wrote about a decision from a New Mexico bankruptcy court holding that the automatic stay was not applicable to the removal of a state court action to bankruptcy court and to the continuation of that there. Earlier this week, in response to a motion for reconsideration, the court partially reversed itself, again holding that the automatic stay is not applicable to removal or to motions to remand the action back to state court, but holding that continuation of the action, beyond mere consideration of a motion to remand, was barred by the automatic stay. In re Cashco Inc., No. 18-11968-j7 (Bankr. D.N.M. March 26, 2019).

To review, this case involves Cashco Inc., which filed for bankruptcy in 2018. Before Cashco filed for bankruptcy, it had been sued, along with other defendants, in a state court action brought by Matthew Kitts. Cashco filed a notice of removal removing the state court action to bankruptcy court. Kitts filed a motion for remand and abstention. The chapter 7 trustee (the “Trustee”) objected to both the removal and the motion for remand on the ground that they violated the automatic stay, and the court ordered briefing on the question. On February 12, 2019, as summarized in our previous post, the court held that the automatic stay did not bar removal of a case to bankruptcy court, nor did it bar continuation of a case within bankruptcy court, as long as the bankruptcy court in question is the one where the debtor’s (here, Cashco’s) bankruptcy case is pending. The court reasoned that while a literal application of the automatic stay provision might apply it here, the fundamental purpose of the automatic stay is to centralize litigation in the bankruptcy court, so proceedings against the debtor in bankruptcy court should be exempt from the automatic stay. In the alternative, in case a higher court disagreed with its ruling on the applicability of the automatic stay, the court retroactively annulled the automatic stay as to the removal.

On February 28, the Trustee filed a motion for reconsideration. The Trustee recognized that the ultimate effect of the court’s order in this case was unlikely to change, but objected to certain aspects of the ruling that he characterized as setting bad precedent on the applicability of the automatic stay. The Trustee argued that a general rule exempting from the automatic stay all proceedings against a debtor in the same bankruptcy court as the debtor’s case would defeat the purpose of the automatic stay in many cases. For example, it would mean that the automatic stay would not apply to an adversary proceeding against a debtor who files for bankruptcy while the adversary proceeding is ongoing, as long as both the adversary proceeding and the debtor’s bankruptcy filing are in the same court. It would also mean that creditors in ongoing proceedings against a debtor when a bankruptcy is filed could simply remove the cases to the bankruptcy court hearing the debtor’s bankruptcy case, and then continue the litigation without interruption. Either result would defeat the automatic stay’s purpose of giving the debtor a breathing spell from pending proceedings against it. (The Trustee also objected to the court’s ruling in the alternative retroactively nullifying the automatic stay, noting that no party had requested such an order, contrary to the requirement in Bankruptcy Code section 362(d) that stay relief be granted only “[o]n request of a party in interest and after notice and hearing.” The court had relied on section 105(a), permitting the court to issue “any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title,” but relying on Law v. Siegel, 571 U.S. 415 (2014), the Trustee argued that section 105(a) cannot be used to supersede requirements found in other parts of the Bankruptcy Code.)

In response to the Trustee’s motion for reconsideration, the court filed a new memorandum opinion superseding the previous one. The court held to its earlier conclusion that the automatic stay does not apply to the removal of a state court action to bankruptcy court. It reasoned that such a removal merely commences an adversary proceeding against the debtor, and commencing an adversary proceeding is not subject to the automatic stay. It further reasoned that merely filing a notice of removal does not advance the pending state court litigation, but simply moves it from one forum to another. Similarly, the court held that the automatic stay does not apply to a motion for remand or abstention, which would simply restore the status quo as it existed at the time of bankruptcy filing, returning the action to its original forum without affecting any party’s substantive rights.

However, the court held, contrary to its earlier ruling, that continuation of a previously-filed action, even in bankruptcy court, would violate the automatic stay. The court reasoned that part of the purpose of the automatic stay is to provide a respite for the debtor from ongoing litigation. Permitting previously-filed litigation to continue without first requiring interested parties to seek relief from the stay would defeat this purpose. The court thus held that the removal and the motion for remand and abstention were valid, but the action itself remained stayed. It also abandoned as unnecessary the portion of its prior ruling annulling the automatic stay with respect to removal.