Automatic Stay in Bankruptcy: What Chicora Life Means for Lenders

by Andrew K. Alper September/October 2016

The recent Chicora Life case has provided additional law for debtors and guarantors to cite as authority when attempting to stay the lender from proceeding against a guarantor. Attorney Andrew Alper examines this case and the history of the automatic stay in bankruptcy proceedings.

Andrew K. Alper,
Partner,
Frandzel Robins Bloom & Csato, L.C.

With very limited exceptions, the automatic stay in bankruptcy pursuant to 11 U.S.C. §362 protects only the debtor, the debtor’s estate and property of the debtor. It does not prohibit the debtor’s creditors from taking action against non-debtors like partners or guarantors, where the non-debtors are closely related to the debtor.1

Unless there is a co-debtor stay applying in a Chapter 13 case, for someone who has not filed bankruptcy to obtain stay protection as a result of the debtor filing bankruptcy, the debtor or trustee must file an adversary proceeding for an injunction pursuant to 11 U.S.C. §105 barring creditors from taking action against the non-debtor.2 The usual preliminary injunction standard applies, and to prevail the debtor or trustee must show:

  1. A likelihood of success on the merits
  2. The likelihood of irreparable injury if preliminary injunctive relief is not granted
  3. The balance of equities favors the debtor/trustee, and
  4. The granting of the injunction is in the public interest3

Even a debtor’s non-filing spouse is not protected by a debtor’s automatic stay, with two exceptions. The stay bars acts against community property because it is property of the estate.4 Similarly, where both a debtor and a non-debtor spouse have co-ownership interests in the property, like a joint tenancy, a creditor cannot foreclose on or repossess the property without first obtaining relief from the stay.

To protect non-debtor guarantors from a creditor’s lawsuit, courts rarely grant an injunction unless there are circumstances in Chapter 11 cases where the debtor demonstrates that an injunction is necessary to protect the debtor’s ability to reorganize. Likewise, a bankruptcy of one defendant in multiple defendant cases does not stay the case as to the remaining defendants except where the debtor is an indispensable party or for “unusual circumstances” where an action against the non-debtor might have a significant adverse impact upon the debtor.

Some courts, like the 9th Circuit, have not expressly adopted the “unusual circumstances” exception, but also have not rejected the concept, noting that lower courts in the circuit have applied the exception.5

Chicora Life

This brings us to the recent case of Chicora Life Ctr., LC v. UCF 1 Trust 1.6 In this case, a Chapter 11 debtor was a single-asset real estate debtor as defined by 11 U.S.C. §101(51B). The debtor sought a preliminary injunction to prevent the lender from filing a legal action based upon a “springing” personal guaranty of the principal of the debtor, Douglas M. Durbano.

The lender made demand upon Durbano for payment of the sum of about $15.6 million on his guaranty obligation. The lender also was secured by a first deed of trust on the single asset real estate property which the debtor contended had a value of $35 million to $37 million. The bankruptcy estate consisted of a loan secured by a junior lien on the property of $6.9 million and unsecured creditor claims of approximately $169,500 held by 17 creditors.

The debtor’s plan of reorganization called for Durbano to provide a personal contribution of no less than $1 million to pay operating expenses and necessary pre-occupancy tenant improvements for the debtor’s property. Durbano also testified that he was a guarantor on a line of credit which was expected to be renewed in approximately four months. The $1 million cash contribution from Durbano to the debtor would come from that line of credit.

The debtor contended that if the lender filed a collection action against Durbano on the guaranty, it would impede, hinder and adversely affect Durbano’s ability to renew the line of credit and jeopardize the debtor’s ability to fund its operations and plan of reorganization. Among the more interesting terms of the guaranty was a waiver by Durbano of the right to seek an injunction under §105 to prevent the lender from pursuing him in the event of a default on the loan and subsequent bankruptcy.

Related Case Law

The lender was unable to present any case law addressing the enforceability of a prepetition waiver of a debtor’s right to request a §105 bankruptcy stay or injunction against the non-debtor guarantor. However, the lender analogized this waiver to the debtor’s right to waive any objection to a motion for relief from stay pursuant to 11 U.S.C.§ 362 if there was a bankruptcy.

Apparently, in the District of South Carolina where this case arose, the cases of Darrell7 and Cheeks8 uphold the validity of a waiver of the debtor’s right to object to a motion for relief from stay prior to the filing of a bankruptcy petition so that once the debtor files bankruptcy, there is no automatic stay to prevent the lender or creditor from foreclosing on property or pursuing other stayed activity.

This is not true in many other courts, which will not allow private agreements that would deprive a debtor of the use and benefit of property upon filing of a bankruptcy case.9 Waivers in guaranties of rights in bankruptcy prior to filing bankruptcy are more likely to be enforceable when there is separate consideration for the waiver and part of a restructuring agreement on a defaulted loan.10

Injunction Granted

Regardless of the argument by the lender that the waiver by the guarantor of obtaining an injunction against him pursuant to §105 was akin to a similar waiver of §362, the court would not enforce such waiver. The court looked at the waiver of this injunction as being analogous to depriving a debtor of the benefits of filing bankruptcy, which the court stated has been repeatedly denied on public policy grounds.

The bottom line in this case:

  1. The court granted an injunction in prohibiting the lender from filing a lawsuit against the guarantor because such a lawsuit would have affected the debtor’s ability to formulate a Chapter 11 plan and adversely affect the bankruptcy estate.
  2. The debtor was likely to succeed on the merits by showing that it could have a reasonable likelihood of reorganization.
  3. The debtor demonstrated that it would suffer irreparable harm in the absence of an injunction.
  4. The balance of equities was tipped in the debtor’s favor.
  5. The injunction was in the public interest because it promoted a successful reorganization of the debtor, which will provide a significant benefit to the community in which the debtor was located.

However, sifting through the legalese in the case, it appears that what the court really did with this ruling was tell the lender that it had so much equity in the property that it should not be filing a lawsuit against the guarantor. This is especially true with a single-asset real estate debtor where a plan has to be filed on an expedited basis so there will be no long delay in filing and confirming a plan.

In addition, the evidence showed that the debtor was currently negotiating a takeout loan, which would not only provide future capital to the debtor but also repay both loans and all of the debt in full. In addition, the waiver of the injunction language was in the guaranty but not in the loan documents. Therefore, the debtor could argue that it never agreed to waive the right to obtain an injunction pursuant to §105.

Consequently, behind the court’s legal ruling are facts which demonstrate that there was really no reason for the lender to proceed with litigation against the guarantor given the equity cushion in the property and the status of the case. But now there is additional law for debtors and guarantors to cite as authority when they attempt to stay the lender from proceeding against a guarantor notwithstanding the plain language in the guaranty.

Footnotes

  1. See In re Chugach Forest Products, Inc. (9th Cir. 1994) 23 F.3d 241, 246; United States v. Dos Cabezas Corp., (9th Cir. 1993) 995 F.2d 1486, 1491-1492.
  2. See e.g. In re Excel Innovations, Inc. (9th Cir. 2007) 502 F.3d 1086, 1094-1095; In re American Hardwoods, Inc. (9th Cir. 1989) 885 F.2d 621, 624-626.
  3. See Winter v. Natural Resources Defense Counsel, Inc. (2008) 555 U.S. 7, 23.
  4. See 11 U.S.C. §541(a)(3).
  5. See In re Chugach Forest Products, Inc. (9th Cir. 1994) supra at 247 and fn. 5.
  6. In re Chicora Life Ctr., LC. 2016 Bankr. LEXIS 2594 decided on June 15, 2016.
  7. In re Darrell Creek Assoc. LP, 187 B.R. 908, 913 (Bankr. D.S. C. 1995)
  8. In re Cheeks, 167 B.R. 817 (Bankr. D.S. C. 1994)
  9. See Matter of Pease (DC NE 1996), 195 B.R. 431, 433; In re Jenkins Corp. Assocs. Ltd. Partnership (BC ED PA 1995), 181 B.R. 33, 36-37; In re Bryan Road LLC (BC FL 2008) 382 B.R. 844.
  10. See In re Excelsior Henderson Motorcycle Mft. Co., Inc. (BC SD FL 2002) 273 B.R. 920, 923-924).

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