Reversing the bankruptcy court and setting aside $19 million in sanctions, a district judge in New York handed down an opinion on October 6 that could be read to mean that misleading advertising designed to poach a debtor’s customers does not violate the automatic stay.
The debtor, a provider of commercial and residential communications services, filed a chapter 11 petition to reorganize. A competitor mounted a direct mail campaign targeting the debtor’s customers.
The competitor’s advertising announced that the debtor was in chapter 11 and asked whether the debtor would be able to stay in business. For example, the advertising said that the debtor’s future was “unknown” and insinuated that the debtor might cease providing services.
Alleging that the advertising was “knowingly false” and caused “confusion” among its customers, the debtor filed an adversary proceeding in bankruptcy court contending that the competitor had violated the automatic stay.
On summary judgment, the bankruptcy court held that the competitor’s advertising violated the automatic stay in Section 362(a)(3) as “an act to control property of the estate, namely, the debtors’ customers or contracts with those customers.” After trial, the bankruptcy court issued an order imposing almost $19.2 million in sanctions for a “literally false and intentionally misleading advertising campaign that wrongfully interfered with the Debtors’ customer contracts and goodwill.”
District Judge Cathy Seibel reversed on appeal. Sitting in White Plains, N.Y, she analyzed whether the advertising violated the automatic stay and whether, under Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), there was a “fair ground of doubt” about the advertising as a stay violation.
Control over Estate Property
Although she found the evidence to be “quite thin,” Judge Seibel said that the bankruptcy court “did not clearly err in concluding that [the debtor] had some kind of contracts under which it provided services to at least some customers.” However, she went on to explain why the “advertisements were not acts to ‘obtain’ or ‘control’ any such contracts,” even if the debtor’s goodwill was also protected by the automatic stay.
The governing statute, Section 362(a)(3), proscribes “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” Judge Seibel said that the “plain language of this statute does not clearly encompass solicitation of a debtor’s customers, which one does not typically regard as ‘exercising control’ over ‘property.’”
Judge Seibel went on to say that “there is nothing in the ‘plain terms’ of § 362(a)(3) that suggests that ‘improper’ advertisements are methods of ‘control’ but ‘legitimate’ ones are not.” She said that “[t]he statute does not prohibit all conduct that harms or interferes with a debtor’s business, but only that which amounts to an effort to obtain or control estate property.” [Emphasis added.]
Even if the competitor’s advertising violated non-bankruptcy laws, Judge Seibel said it was “not clear how it was an act to ‘exercise control’ over contracts or goodwill.” She added that it was not correct to say that “any attempt to compete with an entity going through reorganization would be stayed, whether wrongful or not.”
Focusing on the language of the statute, Judge Seibel said,
[T]the customer is not property of the estate. It is thus difficult to see how, without more, influencing or manipulating a customer to opt for a competitor’s service over a debtor’s through advertisements, false or otherwise, is an act of control over estate property.
In other words, Judge Seibel said, “The mere fact that the conduct may be wrongful or unlawful does not automatically convert it into a violation of the automatic stay.”
Judge Seibel found no stay violation because the “advertisements cannot reasonably be seen as an act to exercise control over property of [the debtor’s] estate.”
Taggart Issues
Even if there were a stay violation, Judge Seibel asked whether there was a “fair ground of doubt” about a stay violation to exonerate the competitor under Taggart, supra,139 S. Ct. 1799, 1801.
Judge Seibel quoted the bankruptcy court for saying, in substance, that someone in doubt about whether an act would violate the stay should first seek a so-called comfort order from the bankruptcy court. She said that Taggart rejected a “substantially similar standard” under Section 105(a).
Although there are differences between the discharge injunction in Taggart and the automatic stay in the case on appeal, Judge Seibel said it was “contrary to Taggart to read into § 105(a) a requirement that a creditor ‘seek clarification from the court or be sanctioned for shooting first and aiming later’ if the creditor is unsure whether its contemplated course of conduct would run afoul of the automatic stay.” She therefore held that “there is no requirement that the would-be violator move to lift the stay prior to acting.”
Because it was “at least highly debatable” whether the advertising amounted to an attempt to “exercise control” over estate property, Judge Seibel held that the bankruptcy court abused its discretion by holding the competitor in contempt. She vacated the contempt citation and the $19.2 million sanction.
It Ain’t Over Yet
The competitor is not out of the woods.
The debtor had also sued the competitor in bankruptcy court for violating the Lanham Act and state law equivalents. Judge Seibel had withdrawn the reference.
Despite the reversal of the contempt finding, Judge Seibel said that the debtor “still may pursue its false advertising and breach of contract claims.”
Reversing the bankruptcy court and setting aside $19 million in sanctions, a district judge in New York handed down an opinion on October 6 that could be read to mean that misleading advertising designed to poach a debtor’s customers does not violate the automatic stay.
The debtor, a provider of commercial and residential communications services, filed a chapter 11 petition to reorganize. A competitor mounted a direct mail campaign targeting the debtor’s customers.
The competitor’s advertising announced that the debtor was in chapter 11 and asked whether the debtor would be able to stay in business. For example, the advertising said that the debtor’s future was “unknown” and insinuated that the debtor might cease providing services.
Alleging that the advertising was “knowingly false” and caused “confusion” among its customers, the debtor filed an adversary proceeding in bankruptcy court contending that the competitor had violated the automatic stay.