Peter J. Benvenutti

On CREDITOR'S RIGHTS

  Almost all civil litigators and state court judges know about the automatic bankruptcy stay. Bankruptcy Code § 362. Most know that that the stay is very broad in scope - enjoining a wide range of legal proceedings and other debt enforcement actions against the bankruptcy debtor - and that acts in violation of the stay can trigger severe monetary sanctions. In most federal judicial circuits (including the Ninth), actions in violation of the automatic stay are absolutely void, not merely voidable. Hence, to continue with litigation or other debt enforcement proceedings in violation of the automatic stay is likely to be a waste of time and money, at best.
    But whether the automatic stay applies to a particular activity or proceeding is not always easy to decide. For example, the stay bars actions to recover claims against the debtor, but not claims by the debtor. How then to classify an action by the debtor as plaintiff with counterclaims which might result in an affirmative recovery by the defendant? The stay prevents proceedings to recover or exercise control over property of the bankruptcy estate. But how about a declaratory relief or interpleader action in state court to determine the rights of the debtor and others in property (say funds in escrow, or rights under an insurance policy) to which the debtor and others assert conflicting claims? Or funds deposited by the debtor in the court's registry which the court has - pre-bankruptcy - ordered paid to another party? What about the sometimes factually ambiguous statutory exceptions to the automatic stay? For example, is an action by a governmental agency to compel a debtor to spend money on environmental clean-up within the "police powers" exception of § 362(b)(4), or is it instead an action to enforce a financial obligation (and hence not excepted)?
    When this kind of question arises in an action pending in state court, can the non-debtor party ask that court to rule that the stay is inapplicable, and safely rely on such a ruling? There is some case authority supporting this approach. Some courts (including some bankruptcy courts) have held that a non-bankruptcy court can decide whether the stay applies to litigation pending before it, and that such a decision is not subject to collateral attack in the bankruptcy court.
    Recently, however, the Ninth Circuit has categorically rejected this view, holding in a unanimous en banc decision that only the bankruptcy court can authoritatively decide whether the automatic stay applies. In re Gruntz, 202 F.3d 1074 (9th Cir. 2000).
    Robert Gruntz was prosecuted in LA Municipal Court during his 1988 bankruptcy case, and convicted, for failing to pay child support. He asserted in state court that the prosecution was barred by the automatic stay, but lost in both the trial court and on appeal. People v. Gruntz, 29 C.A. 4th 412 (1995). After conviction but before sentencing he filed an adversary proceeding in bankruptcy court seeking a TRO to suspend the criminal proceedings; the TRO was denied. After the conviction was affirmed, Gruntz filed a second adversary proceeding in bankruptcy court for a declaration that the conviction was void because in violation of the automatic stay.
    When the bankruptcy court dismissed Gruntz's second adversary proceeding as collaterally estopped by the state court criminal conviction, he appealed to the district court. It affirmed based on the Rooker-Feldman doctrine, which bars lower federal courts from reviewing most final decisions of a state court. Gruntz, motivated no doubt by the dual desires to avoid doing time and to remove an impediment to issuance of his law license, appealed to the Ninth Circuit. In a published split decision, the Ninth Circuit reversed, holding that the state courts do not have any jurisdiction to decide the applicability of the automatic stay, and thus Gruntz's adversary proceeding was not barred by either collateral estoppel or Rooker-Feldman. In re Gruntz, 166 F.3d 1020 (1999). In an amended opinion, the panel - still divided - modified its rationale slightly to hold that state courts do not have preclusive jurisdiction to decide the applicability of the stay, and again reversed and remanded to the bankruptcy court to decide if the stay applied. Id., 177 F.3d 728. On request of the state authorities, the Ninth Circuit granted rehearing en banc, withdrew the prior opinions, and held unanimously that, because the automatic stay plays such a central role in the federal bankruptcy process, only "the federal courts have the final authority to determine [its] scope and applicability…." Id., 202 F.2d at 1083 (emphasis added). Unfortunately for Mr. Gruntz, his victory on the jurisdictional question was a hollow one. The Court of Appeals ruled against him on the merits, and held that, as a matter of law, the automatic stay doesn't bar any criminal prosecution, even if its alleged object is debt collection.
    Under Gruntz, a decision by a state court that the automatic stay doesn't apply is apparently always open to second guessing by the bankruptcy court. The lesson for litigators, especially in the Ninth Circuit, seems pretty clear. If there is any doubt whether the automatic stay applies to your lawsuit, ask the bankruptcy court to resolve it, or you may find the debtor years later asking the bankruptcy court to set aside your client's judgment and to nullify all your efforts in the meantime. On the other hand, if you're sure that the stay doesn't apply, and that any bankruptcy judge will agree with you, go right ahead and ask the state court to let you try your case.

Mr. Benvenutti is a shareholder in the firm of Heller Ehrman White & McAuliffe LLP.
pbenvenutti@hewm.com