Bankruptcy Update Blog

Bankruptcy Court Holds Automatic Stay Inapplicable to Removal of State Court Action Against Debtor

When a party files for bankruptcy, the Bankruptcy Code imposes an automatic stay of litigation against a debtor for claims arising prior to the commencement of the bankruptcy case. See 11 U.S.C. § 362(a). Where there is a basis for bankruptcy jurisdiction in federal court, federal law also permits parties to a state court action to remove the state court action to the federal district court for the district in which the state court action is pending. See 28 U.S.C. § 1452(a). (Usually, the action will then be automatically referred to a bankruptcy court in that federal judicial district.) Absent court action to modify the automatic stay, does the automatic stay block parties from carrying out such removal of state court actions against a bankruptcy debtor? In In re Cashco Inc., No. 18-11968-j7 (Bankr. D.N.M. December 12, 2018), a bankruptcy court considered an objection to removal on this ground by a chapter 7 trustee (“the Trustee”). While noting that courts have split on this issue, the bankruptcy court ruled that the automatic stay does not apply to removing a case to the bankruptcy court where the bankruptcy case is pending, nor to other proceedings in that court, including continuation of the removed action.

Cashco Inc., the Debtor, filed a voluntary petition under chapter 7 on August 6, 2018. Prior to its petition, Matthew Kitts filed an action in New Mexico state court against the Debtor. On August 23, 2018, the Debtor filed a notice of removal removing the state court action to bankruptcy court. Kitts filed a motion for remand and abstention. The Trustee objected that both the removal to bankruptcy court and the motion for remand and abstention violated the automatic stay and therefore were void. The court stayed the motion for remand and abstention and ordered briefing on the automatic stay issue.

The court began its analysis by reviewing the support for the position that the automatic stay is applicable to the removal of state court actions against a bankruptcy debtor and their continuation in bankruptcy court. It noted that the plain language of the automatic stay provision seems applicable, several cases have held that the bankruptcy stay bars removal of state court lawsuits to bankruptcy court, and the Advisory Committee Notes to the Bankruptcy Rule providing for removal suggest that a removed state court action subject to the stay remains subject to the stay following removal to the bankruptcy court.

Nonetheless, the court concluded that the automatic stay does not apply to removal of an action to the bankruptcy court where the debtor’s case is pending, nor to continuation of the action in that court. While the plain language of the automatic stay provision does not distinguish between proceedings in bankruptcy courts and proceedings in other courts, the court reasoned that reading the automatic stay to apply to proceedings against the debtor in the home bankruptcy court would be illogical. The purpose of the automatic stay is to centralize claim collection efforts in the bankruptcy case. If the stay applied to claim collection efforts in bankruptcy court, then, the court reasoned, it would apply to proofs of claim, objections to a debtor’s claim of exemption, and other essential parts of the bankruptcy process. The court thus concluded that proceedings against the debtor in the bankruptcy court where the debtor’s bankruptcy case is pending are generally exempt from the stay, and held that this logic applied both to the removal itself and to continuation of the action in the bankruptcy court.

The court rejected the case law to the contrary, asserting that courts that had held otherwise had failed to acknowledge the fundamental purpose of the automatic stay. Since the court saw the purpose as centralizing litigation in the bankruptcy court forum, the court held that applying the stay to actions within the forum was inconsistent with that purpose and interfered with the administration of the bankruptcy estate. The court noted that other concerns with removal, such as forum-shopping and the presence of an additional defendant in the removed action that is not in bankruptcy, are best addressed through a request for abstention and remand, not an objection under the automatic stay.

Acting of its own accord, as an additional step in case a higher court disagreed with its analysis, the court also retroactively annulled the automatic stay as to removal and modified it as to permit continuation of the action, to the extent the automatic stay in fact applied.