Unbeknownst to a foreclosing creditor, the personal representative of the deceased sole shareholder of a corporation that had been administratively dissolved more than a decade ago filed a chapter 7 bankruptcy petition on behalf of the corporation three days before the foreclosure sale of real estate owned by the corporation. After learning of the bankruptcy, the creditor sought to annul the automatic stay and retroactively validate the foreclosure sale.
Under 362 of the Bankruptcy Code, the automatic stay goes into effect automatically upon the filing of a bankruptcy petition. As stated in several cases quoted by the bankruptcy court, its purpose is “to provide the debtor a ‘breathing spell’ from collection efforts and to shield individual creditors from the effects of a ‘race to the courthouse,’ thereby promoting the equal treatment of creditors.” Actions taken in violation of the stay are voidable.
The secured creditor’s initial argument was that the case was not properly commenced, so the stay did not go into effect. Looking to state law, the court concluded that, although the corporation was dissolved, it continued to exist for purposes of winding up its affairs so that it had the capacity to commence a chapter 7 liquidation or a liquidating chapter 11 bankruptcy.
With respect to the authority of the personal representative to file the petition, the court cited state law for the proposition that upon dissolution of the corporation its shareholder succeeded to equitable ownership of corporate assets subject to claims of creditors. Further, upon the shareholder’s death (which occurred subsequent to the corporate dissolution), his personal representative became authorized to take control of his interests in the corporation’s assets, which included authority to file the bankruptcy petition on behalf of the corporation.
Given that the bankruptcy filing was proper and thus the automatic stay was in effect, the next issue was whether the secured creditor was entitled to relief from the automatic stay under Section 362(d) of the Bankruptcy Code. The court’s power to grant relief includes the power to annul the stay. This allows the court to retroactively validate actions that would otherwise be voidable as violations of the automatic stay.
Generally annulment requires “extraordinary circumstances.” A common example is a bad faith bankruptcy filing by the debtor. The creditor’s lack of knowledge of the automatic stay combined with unfair prejudice to the creditor was also cited as grounds in some cases. Other cases suggest that prejudice to the creditor arises only where the debtor unreasonably withheld notice to the prejudice of the creditor or where the debtor attempts to use the stay unfairly as a shield. Yet another case identified by the court suggests that unless there is bad faith, retroactive relief is justified only if the creditor had no knowledge of the stay and would have been entitled to relief if relief had been requested prior to taking the action in violation of the stay. In other words, there is no clear cut answer.
The parties agreed that, although the bankruptcy was filed three days before the sale and the creditor was listed in the debtor’s schedules and sent notice of the bankruptcy case, the creditor did not have notice before conducting the sale.
However, there was also no indication that the debtor withheld notice, or that the case was filed in bad faith, or that the debtor was attempting to use the automatic stay unfairly as a shield. In that regard, the court noted the view that filing for bankruptcy on the eve of foreclosure may be probative, but is not by itself bad faith.
Given that the debtor did not abuse the bankruptcy process, the court concluded that denial of the requested retroactive stay relief would merely put the secured creditor on the same level as the other creditors (i.e. furthering the goal of avoiding a race to the courthouse and promoting equal treatment of creditors). The court also did not find that the creditor would be unduly prejudiced (for example, if it had incurred improvement costs). Consequently, the foreclosure sale was declared void and the property remained part of the bankruptcy estate.
In this case the creditor sold the property to the debtor in 2001 and financed at least a portion of the purchase price, which was secured by a deed of trust on the property. When the creditor foreclosed on the property almost 11 years later, he was the purchaser at the foreclosure sale.
Although the opinion does not go into any details, it is reasonable to speculate that the chapter 7 trustee believed that there was some equity in the property (since otherwise it is difficult to see why the trustee would go to the trouble of voiding the sale). However, unfortunately for the secured creditor, there is no assurance that the eventual sale of the property by the trustee will result in proceeds sufficient to pay off the secured creditor. A creditor in this position should consider taking affirmative steps to protect its interests, such as requesting some form of adequate protection under Section 361 of the Bankruptcy Code, rather than simply waiting for an eventual sale by the trustee.
Vicki R. Harding, Esq.