A bankruptcy filing by a property owner may not be the only action that prevents foreclosure of a security interest in that property held by a secured creditor. In a growing list of cases, courts also have held the bankruptcy of a junior secured creditor with a lien on the property invokes the automatic stay against such action. In one such case, a federal bankruptcy court in Texas held that the bankruptcy filing by an entity that held a second secured lien on property of a nonbankrupt borrower automatically stayed a foreclosure action by the senior secured lender with a lien on the same property. See In re Three Strokes L.P., 379 B.R. 804 (Bankr. N.D. Tex. 2008).

In Three Strokes, certain Arizona real property was owned by Citadelle at Arrowhead Ranch, LLC. Citadelle was owned by two other entities, Arrowhead Point, Inc. and Bean Premier, LLC. Long before the dispute at issue, Citadelle borrowed approximately $28 million from an entity that had transferred the loan to Conseco by the time of the bankruptcy case. The loan was secured by a first lien on the Arizona real property, assignment of rents and other personal property relating to a 100,000 sq. ft. mixed-use retail and office facility, and 10 acres of additional real property. The loan also was guaranteed by an individual, Albert Paul Stevens.

Conseco appears to have been an outsider to a series of incestuous relationships between the debtor, Three Strokes, Citadelle, the actual owner of the 100,000 sq. ft., 10 -cre real estate at issue; Citadelle’s owners, Arrowhead Pointe, Inc. and Bean Premier, LLC; and Mr. Stevens. The court noted that all of the shares of Arrowhead Pointe were owned by the debtor, Three Strokes, and that the shares were subject to a pledge to Bean Premier. Stevens was a “principal” of Citadelle and signed a voluntary petition of debtor Three Strokes as president of the general partner of the debtor.

First Security Interest

Conseco had, however, a first-secured security interest that was in default, and a written “Intercreditor Subordination Agreement” with Three Strokes, fully and completely subordinating Three Strokes’ security interest in the property to Conseco’s security interest in the property. There was conflicting appraisal evidence as to whether the value of the property was enough to fully secure Conseco’s lien, and whether there was some possible additional value that might be available to Three Strokes as second lien holder.

On a motion for relief from stay, and alternatively for a determination that the stay simply did not apply, the bankruptcy court held that the stay was applicable. The court further ruled that a decision as to whether the stay ought to be lifted would be made based on the usual factors: cause and lack of adequate protection for Conseco’s lien.

Thus, the Three Strokes court joins a lengthening list of bankruptcy courts that have held that a bankruptcy filing by the holder of a junior lien on property of a nonbankrupt owner automatically triggers the protection of the bankruptcy stay, precluding enforcement of liens against that property by a senior secured lender. These courts have held this to be the case even though the owner of the property and the obligor to the senior secured lender are not in bankruptcy.

In so holding, the bankruptcy court provided the clearest statement yet of the logic behind this decision: the property on which both senior and junior lien holders have liens is not the property of the bankruptcy estate. The second lien interest of Three Strokes, however, is property of the Three Strokes bankruptcy estate. The foreclosure proceedings by Conseco would have the effect of extinguishing Three Strokes’ second lien interest, and would give Conseco control over property of the Three Strokes estate.

Purpose of the Stay

Conseco argued that Section 362(a) of the Bankruptcy Code is designed to stop creditor collection actions. The court, however, noted that Section 362 actually designates “all entities” as targets of the stay. The stay’s general purpose—to prevent disbursement of the bankruptcy estate and allow a breathing spell for a debtor-in-possession to collect itself—applies equally in instances in which an asset is a lien as it does when it is the dirt itself.

The court’s decision is in line with earlier decisions such as Florida Inst. of Tech. v. Carpenter (In re West Tech Corp.), 460 F.2d 1139, 1142 (5th Cir. 1972) (a chapter X case); In re Chestnut, 433 F.3d 298, 303 (5th Cir. 2005); Fidelity Mortgage Investors v. Camelia Builders, Inc., 550 F.2d 47 (2nd Cir. 1976) (a chapter XI case); In re Capital Mortgage and Loan Inc., 35 B.R. 967 (Bankr. E.D. Cal. 1983); and Cardinal Indus., Inc. v. Buckeye Fed. Sav. and Loan Ass’n (In re Cardinal Indus. Inc.), 105 B.R. 834 (Bankr. S.D. Ohio. 1989).

In enforcing the automatic stay, the court declined to follow contrary case authority. These include Farmers Bank v. March (In re March), 140 B.R. 387 (E.D. Va. 1982), which was affirmed by the U.S. Court of Appeals for the Fourth Circuit at 988 F.2d 498, but the affirmation was on procedural grounds and not the substantive issue of the automatic stay. Other cases in this line of authority include In re Le Peck Constr. Corp., 14 B.R. 195 (Bankr. E.D.N.Y. 1981) and In re Holiday Lodge, Inc., 300 F.2d 516 (7th Cir. 1962).

The bankruptcy court ultimately determined that a trial was needed on the factual issues concerning whether there was cause for relief from the automatic stay. The legal result reached by the Three Strokes court, however, adds additional weight to the proposition that a junior lienholder seeking bankruptcy protection can preclude the enforcement of a senior lien, even though the owner of the encumbered property has not sought (and may not even be eligible for) bankruptcy relief.