Courts have wrestled with the definition of “individual” in the context of proceedings or defenses resulting from a violation of the automatic stay that arises when a corporation files for bankruptcy. Historically, a violation of the stay is brought by the trustee or debtor in possession, although the statute governing the automatic stay permits any “individual” to bring a stay violation. Recently, the Fifth Circuit, in St. Paul Fire & Marine Ins. Co. v. Labuzan [1] (“Labuzan”), interpreted “individual” as including creditors of the estate as well as debtors and trustees. Therefore, a creditor as an “individual” under the statute had standing to bring a claim for damages for violations of the automatic stay.
Labuzan drastically expanded the benefit of the stay provision from only debtors and trustees to all creditors. This article will discuss the automatic stay in conjunction with other bankruptcy provisions, the Fifth Circuit’s holding in Labuzan, the Ninth Circuit’s holdings regarding stay violations, and the implications of the Fifth Circuit’s decision within the context of the construction industry and within the context of bankruptcy.
Automatic Stay and Relevant Statutes
The automatic stay arises as a result of voluntarily or involuntarily filing for bankruptcy, and serves as an injunction to give debtors “a breathing spell from creditors” [2] to reorganize or liquidate. Prior to the Fifth Circuit’s decision in Labuzan, no court had permitted human creditors to have standing to bring a claim for damages as a result of a willful violation of the automatic stay under §362(k). In 1989, the Fifth Circuit, in Pettitt v. Baker, expanded remedies for willful stay violations, which had previously been reserved for the bankruptcy courts, by holding that a debtor had standing to pursue a private remedy under §362(k). [3] Subsequently, the term “individual” was interpreted to include debtors,[4] the United States, [5] and creditor corporations. [6]
To determine if a creditor is an “individual” who is injured by a willful violation of the automatic stay, §362 must be read in conjunction with other provisions of the Code. Section 362 must be read with §1109, [7]which describes who can appear and be heard on issues in a bankruptcy case. Section 1109 permits a party in interest to raise, appear and be heard on any issue in bankruptcy. [8] Therefore, permitting human creditors to have standing under §362(k) does not conflict with standing in bankruptcy under §1109. [9]
Section 362 must also be read together with §541, [10] which describes the bankruptcy estate. Since §541governs the creation of the estate, if the damages from the violation of the stay belong to the estate under §541, the trustee, not the creditor, would have standing for this claim. However, under §541, any action regarding the interests of the estate must necessarily involve any interests as of the “commencement of the case” and a violation of the automatic stay can only occur after the stay arises following the filing of bankruptcy. Therefore standing to bring a stay violation is not limited by the estate provision. [11]
Fifth Circuit’s Expansion of Standing for Stay Violations in Labuzan
The Fifth Circuit in Labuzan expanded the definition of “individual” to include creditors as those with standing to bring a claim for damages from a willful violation of the automatic stay. The debtor was a construction company owned by the Labuzans. In accordance with the general practice in the construction industry, the debtor obtained payment and performance bonds in case the corporation was unable to complete construction. The insurer issued the performance and payment bonds on behalf of the debtor for its ongoing projects as insurance for the projects.
In keeping with industry practices, the insurer and the Labuzans entered into an indemnity agreement whereby the Labuzans agreed to be held personally liable if the insurer was forced to pay the project owners on behalf of the debtor pursuant to the bonds. After the debtor voluntarily filed for chapter 11, the insurer contacted the owners of the debtor’s current projects and threatened to reduce the bond insurance if the owners made any payments to the debtor. [12] When the owners stopped sending payments to the debtor, the debtor was forced to convert its proposed chapter 11 into a chapter 7, and could not complete the projects.
The insurer then paid the project owners according to terms of the bonds and then sued the Labuzans in district court according to their indemnity agreement [13] to which the Labuzans raised as an affirmative defense the insurer’s violation of the stay by threatening the project owners. The district court consolidated the bankruptcy case and the indemnity action against the Labuzans. In the bankruptcy case, the debtor and insurer reached a settlement agreement. The settlement was approved, and included a $200,000 claim for the Labuzans against the estate of the debtor, thus making them creditors of the estate. [14]
Subsequently in the indemnity action, the insurer claimed the Labuzans did not have standing to raise a violation of the stay, which was their only remaining affirmative defense, and the district court agreed. The court explained that the debtor was the injured party, not the Labuzans, and the settlement agreement between the debtor and insurer had resolved this issue. Therefore, since the Labuzans did not have a separate claim from the estate, they did not have standing to raise the stay violation. The court explained, however, that it is possible for creditors to have claims for violations of the stay that are independent from the estate, but they must seek equitable remedies on behalf of the debtors, and could not recover damages for themselves. Nonetheless, the court concluded that Labuzans were owners, not creditors of the debtor, and therefore did not have standing for this type of claim anyway. [15] The Labuzans appealed.
The Fifth Circuit determined that the Labuzans had standing because they suffered injury in fact as creditors of the debtor. The Fifth Circuit agreed with the district court that the Labuzans, as owners, did not have standing because the injury to the debtor belonged to the debtor’s estate. However, the Fifth Circuit explained that the Labuzans had a $200,000 claim against the debtor, and as such, were creditors of the estate. Therefore, the Labuzans as creditors had a private right of action and an independent claim for damages against the insurer for violating the stay. The Fifth Circuit vacated the decision of the district court and remanded the case to determine what injuries were sustained by the violation of the stay. [16]
Ninth Circuit’s Narrowing of Standing for Stay Violations
Prior to the Fifth Circuit’s decision in Labuzan, no circuit court had held that an individual creditor had standing for a damage claim based on violation of the automatic stay. The Ninth Circuit consistently denied creditors standing in stay violation actions and held that the stay is for the benefit of the debtor, trustee and estate. [17] Other district courts have also not granted standing for creditors in claims for damages from violations of the stay. [18]
The Ninth Circuit discussed creditor standing for a stay violation in Globe.[19] Globe involved a bankrupt loan company and its sale of its interest in a parcel of land. The parcel of land was collateral for a loan negotiated by the loan company between an owner and fifteen investors. After the owner defaulted, the loan company took an interest in the property and subsequently sold its interest after it filed for bankruptcy. Some investors filed proofs of claim with the bankruptcy court, thereby becoming creditors of the bankrupt loan company. The investor-creditors asserted that the loan company had violated the stay by selling the property. The court denied the investor-creditors standing for a stay violation and explained that they were not bringing the action as creditors, but as owners of the property even though they had filed proofs of claim. [20] The court avoided determining if creditors had standing for to assert a stay violation by categorizing the investors as owners of the property, and not as creditors of the estate.
In Pecan Groves, the Ninth Circuit denied a creditor’s standing to appeal based on a violation of §362. [21] The court determined that when the trustee did not appeal a stay violation decision, the creditor could not appeal the decision because a creditor did not have standing. The court explained that “allowing unsecured creditors to pursue claims the trustee abandons could subvert the trustee’s powers.” [22] Thereafter, the Ninth Circuit interpreted from dicta in other cases that the protections of the automatic stay were for the benefit of trustee, therefore no other party, including a creditor, could make a stay violation claim. [23]
However, more recently in International Forex, [24] a California district court seemed to disregard the framework regarding standing for creditors to assert stay violations. The district court explained Pecan Groves was “overstated for the proposition that the automatic stay is solely for the benefit of the debtor,” and that creditors could not have standing under §362. [25] The district court further concluded that there was “ample authority for the proposition that the automatic stay is intended to benefit creditors, as well as debtors,” [26] and extended standing to include creditors for stay violations by the debtor’s principal.
Tensions Between Fifth and Ninth Circuits
After Labuzan, it is clear that the Fifth Circuit and the Ninth Circuit are at odds. The Fifth Circuit has explicitly held that a creditor may have an independent claim against another creditor for damages resulting from a violation of the stay. The Ninth Circuit has consistently avoided discussing standing for creditors in stay violations by limiting standing to trustees and debtors. By permitting creditors to have standing to bring claims for damages from a stay violation, and by allowing those claims to be independent, private rights of action apart from the estate, the Fifth Circuit has drastically moved away from the narrow interpretations of the Ninth Circuit.
The Fifth Circuit’s holding in Labuzan is important both within the specific context of the construction industry and within the context of bankruptcy. Labuzan may affect in the construction industry because the facts of Labuzan are likely to repeat themselves. It is common practice for construction companies to obtain bonds [27] from large insurance companies, and a vast majority of construction companies are small establishments with less than five employees. [28] Together, these facts suggest that there may be situations where a large bonding company might be able to take advantage of a small construction company, and a situation like the one in Labuzan is likely to occur again.
The Fifth Circuit’s holding in Labuzan is important within the context of bankruptcy as well. Prior to Labuzan, the trustee or debtor was responsible for bringing a stay violation. If the trustee or debtor chose not to bring the stay violation because it was too costly or time consuming, the effect was that a violation of the stay occurred with no punishment for the violator, and no recourse for the injured parties. Now, the Fifth Circuit’s interpretation of “individual” in §362(k) treats all debtors, trustees and creditors uniformly. Allowing creditors to bring a claim for damages arising from a stay violation will ensure that all violators of the stay are punished appropriately, and all injured parties will receive appropriate remedies, which is in line with the overarching bankruptcy policy of equal treatment of creditors. [29] However, this interpretation may be troublesome if creditors begin to take advantage of their standing, leading to a dilution of the trustee’s power as the funnel and gatekeeper or result in unnecessary, tedious litigation. [30]
Conclusion
The Fifth Circuit’s decision in Labuzan clarified the definition of individual within §362, expanded standing to creditors for stay violations, and permitted an individual creditor to have an independent of any claim for damages for this violation. Although the Fifth Circuit’s approach is at odds with the decisions of the Ninth Circuit, it is accordance with the equal treatment of creditors and other guiding principles of the within the Bankruptcy Code.
1. St. Paul Fire & Marine Ins. Co. v. Labuzan, 579 F.3d 533 (5th Cir. 2009).
2. Labuzan, 579 F.3d.at 540 (citing section historical purpose of § 362(k)).
3. 876 F.2d 456, 457-58 (5th Cir. 1989).
4. See Pettitt v. Baker, 876 F.2d 456, 457–58 (5th Cir. 1989) (concluding that private remedy exists for debtor under § 362(k)).
5. See United States v. Miller, No. 5:02-CV-0168, 2003 WL 23109906, at *10 (N.D. Tex. 2003) (permitting United States to have standing to bring stay violation).
6. See Homer Nat'l Bank v. Namie, 96 B.R. 652, 654 (W.D. La. 1989) (permitting creditor corporation to have standing to bring stay violation).
7. 11 U.S.C. § 1109(b) (2006) (“A party in interest, including . . . a creditor . . . may raise and may appear and be heard on any issue in a case under this chapter.”).
8. See § 1109(b).
9. Labuzan, 579 F.3d at 543.
10. 11 U.S.C. § 541(a)(1) (2006) (explaining property of the estate to include “all legal or equitable interests of the debtor in property as of the commencement of the case”).
11. Labuzan, 579 F.3d at 545.
12. Id. at 536.
13. Id.
14. Id. at 537.
15. Id.
16. Id. at 538-39, 545.
17. See Johnston Envtl. Corp. v. Knight (In re Goodman), 991 F.2d 613 (9th Cir.1993) (stating corporate entity was not an individual, therefore no standing). See also Brice v. Stivers (In re Stivers), 31 B.R. 735, 737 (Bankr. N.D. Cal. 1983) (explaining stay benefits debtors and estates, not junior lienholders or other parties interested in property).
18. See Hasdell v. Philadelphia Life Insurance Co. (In re Fuel Oil Supply & Terminaling Inc.), 30 B.R. 360, 362 (Bankr. N.D. Tex. 1983) (stating stay benefits debtor and “if it chooses to ignore stay violations other parties cannot use such violations to their advantage”); Rosenfeld v. 122-24 East 25th Street Corp.(In re Silverman), 42 B.R. 509, 516 (Bankr. S.D.N.Y. 1984) (explaining stay was “not intended to be used as weapons by creditors to the detriment of the estate”).
19. Magnoni v. Globe Inv. & Loan Co.(In re Globe Inv. & Loan Co.), 867 F.2d 556, 558 (9th Cir. 1989).
20. Id. at 560.
21. Tilley v. Vucurevich(In re Pecan Groves of Ariz.), 951 F.2d 242, 245 (9th Cir. 1991).
22. Id. at 245.
23. Id. (“Language from many cases indicates that, if the trustee does not seek to enforce the protections of the automatic stay, no other party may challenge acts purportedly in violation of the automatic stay.”) (citations omitted).
24. 247 B.R. 284 (Bankr. S.D. Cal. 2000).
25. In re Pecan Groves of Arizona, 951 F.2d at 291.
26. Id.
27. Sloan v. Greenville County, 356 S.C. 531, 565 (S.C. Ct. App. 2003) (“[T]he general practice in the field of public procurement is to obtain bonds for the full amount of the contract price.”).
28. See Bureau of Labor Statistics, U.S. Department of Labor, Career Guide to Industries, 2008-09 Edition, Construction, http://www.bls.gov/oco/cg/cgs003.htm (last visited Nov. 17, 2009).
29. See Hunt v. Bankers Trust Co., 799 F.2d 1060, 1069 (5th Cir. 1986).
30. See In re Pecan Groves of Arizona, 951 F.2d at 245.