In re Ebadi, No. 10-73702, 2011 WL 1257211 (Bankr. E.D.N.Y. March 30, 2011)

CASE SNAPSHOT

In this case of first impression, the United States Bankruptcy Court for the Eastern District of New York held that a lender knowingly violated the automatic stay, by proceeding with a foreclosure sale of real property in which the debtor had no interest because the debtor, as a guarantor of the loan, had been named as a defendant in the foreclosure judgment obtained by the lender before the debtor filed for bankruptcy. The results of the foreclosure sale would determine the lender’s deficiency claim against the debtor, i.e., the debtor’s remaining personal liability for the loan. Proceeding with the sale constituted both a continuation of a judicial proceeding against the debtor, and a continuation of a judicial action to recover a pre-petition claim against the debtor, both of which clearly violate the automatic stay. The Bankruptcy Court therefore vacated the foreclosure sale and awarded actual damages to the debtor.

FACTUAL BACKGROUND

Mr. Abadi, the debtor, owned a company called CBC Media Realty. In 2001, CBC executed a note and mortgage in favor of the lender, securing a loan against real property that CBC owned. At that same time, Abadi executed a guaranty, under which he personally guaranteed all payments and obligations due under the note and mortgage. CBC subsequently defaulted, and in 2008, the lender instituted foreclosure proceedings against CBC and Abadi. Early in 2010, the state court entered judgment in favor of the lender, setting May 14, 2010, as the date of the foreclosure sale. The foreclosure judgment included a determination that, if the sale proceeds were insufficient to satisfy the lender’s claim, “the plaintiff shall recover from defendants CBC Media Realty, LLC … and Madjib Ebadi, the whole deficiency … provided a motion for deficiency judgment shall be made.”  

On May 14, 2010, mere hours before the scheduled time of the foreclosure sale, Abadi filed for chapter 13 bankruptcy. The lender’s attorneys and the foreclosure referee were notified prior to the sale of the bankruptcy filing. Nevertheless, the sale proceeded as scheduled, and the lender acquired the rights to the property.  

Abadi neglected to fulfill many of his responsibilities as a chapter 13 debtor, and so on June 29, 2010, his bankruptcy case was closed. On August 24, 2010, the lender served CBC with a Notice to Quit the Premises. On September 8, 2010, Ebadi filed a motion to re-open his bankruptcy case, arguing that the foreclosure sale had violated the automatic stay, that the sale should be vacated, and that he should be awarded actual and punitive damages for the lender’s willful violation of the stay. At a hearing on this motion, Ebadi conceded that he was not seeking to re-open his case in order to reorganize and confirm a plan; he was simply seeking to vacate the foreclosure sale and obtain a damages award.  

The lender argued that it had not violated the automatic stay because the real property was owned by CBC and the debtor had no interest in it.  

COURT ANALYSIS

This case presents an issue of first impression in the Second Circuit: whether a foreclosure sale under New York law of real property in which a bankruptcy debtor has no ownership interest is a violation of the automatic stay, where the debtor is a guarantor of the underlying debt and a named defendant in a foreclosure judgment.

Section 362(a) of the Bankruptcy Code provides: “[A] petition filed under … this title … operates as a stay, applicable to all entities, 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; … (6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title….”

The foreclosure judgment obtained by the lender named the debtor as a defendant, and specifically provided that if the proceeds from the foreclosure sale were insufficient to pay the full amount due, the lender could recover the deficiency from the debtor. The court determined that proceeding with the foreclosure sale constituted a continuation of a judicial proceeding against the debtor. In addition, “[b]ecause the Foreclosure Sale is a substantial step in a process that could lead to recovery of a deficiency judgment from Debtor, it falls within the contours of ‘any act to collect, assess, or recover a claim against the debtor,’ which is prohibited by the automatic stay….” Therefore, the Bankruptcy Court found that the lender had knowingly violated the automatic stay.  

In reaching this conclusion, the court noted the well-established principle of bankruptcy law that, when a principal obligor is a debtor in bankruptcy (and thus shielded by the automatic stay), a creditor is generally not barred from pursuing non-filing co-obligors or guarantors when pursuing the collection of a debt.  

The court, however, distinguished the current case on the grounds that the lender’s actions were taken in furtherance of a foreclosure judgment directly against the debtor. “Had [the lender] dismissed Debtor from the Foreclosure Action and removed Debtor from the Foreclosure Judgment prior to the sale going forward, the case likely would have been sufficiently analogous to collecting from a non-filing co-obligor such that [the lender] would likely not have been stayed from collecting against CBC. That is not the case here, though. Here, [the lender] pursued a Foreclosure Judgment against Debtor while Debtor was protected by the automatic stay.” The court noted that the lender chose to bring the foreclosure action not just in rem (seeking determinations relating to title only), but also in personam (seeking general recovery against individuals or other entities), ultimately allowing the lender to seek a deficiency judgment against the debtor. “An in rem action against property in which a debtor does not have an ownership interest would likely not run afoul with the automatic stay. . . . An action that is at least partially in personam against a debtor, on the other hand, is stayed . . . .”

The Bankruptcy Court concluded that the lender’s violation of the automatic stay was sufficient to vacate the sale and award actual damages. The court, however, found no malicious conduct or bad faith by the lender on which to base an award of punitive damages, and characterized the lender’s continuation with the foreclosure sale as a mistake of law.  

PRACTICAL CONSIDERATIONS

This case is certainly a cautionary tale for lenders. The Bankruptcy Court acknowledged that the debtor filed his chapter 13 petition solely to try to forestall the foreclosure sale, demonstrated no real intention of reorganizing under chapter 13, and admitted to having no intent to reorganize under chapter 13 going forward. Yet, the court, strictly reading the language of section 362, found that the lender had knowingly violated the automatic stay. The important takeaway for lenders, however, is that the violations of the automatic stay discussed in the case are perfectly avoidable. The lender could have either removed the debtor as a defendant or proceeded solely in rem in the first instance. Furthermore, the circumstances were such that, had the lender postponed the foreclosure sale for a limited period of time, the lender most likely would have been able to obtain relief of stay in the debtor’s bankruptcy case, or the debtor’s bankruptcy case would have been dismissed prior to the postponed foreclosure sale.