Attorneys are generally aware that when a defendant that they are pursuing in a state or federal court action files for bankruptcy, an “automatic stay” is imposed under the United States Bankruptcy Code which immediately stays that litigation. Frequently, defendants will file bankruptcy with the hope (if not the express purpose) of either avoiding or delaying entry of an order or judgment. Real property mortgage foreclosure practitioners are all too familiar with last-minute bankruptcy filings on the eve of a foreclosure sale. As an issue that comes up regularly, it is helpful to have a clear understanding of how a defendant’s bankruptcy filing impacts the status of the litigation, particularly where that defendant is appealing state court rulings.
Where the defendant files bankruptcy prior to the state court’s issuance of an order of judgment, the application of the Bankruptcy Code is straightforward and the bankruptcy filing stays “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.” 11 U.S.C. § 362(a)(1).
However, what if the defendant files bankruptcy while in the midst of prosecuting an appeal of a trial court decision? And what if that appeal is fully briefed and argued with nothing else for the parties to do but wait for the appellate court to rule? Some practitioners may be tempted to argue that, at that point, the appeal should proceed undisturbed. However, practitioners might be surprised to learn that, under long standing law in the Second Circuit, which is consistent with courts in other jurisdictions, the bankruptcy stay applies to a pending appeal notwithstanding that such appeal was brought by the debtor/defendant-appellant, provided that the underlying action was originally commenced against the debtor. This may be counter-intuitive to bankruptcy practitioners who know that the stay applies to almost any litigation, enforcement or collection activities that had been pending against the debtor at the time of the filing of the petition in bankruptcy. However, running counter-intuitive is the law that an appeal brought by the debtor as appellant is also subject to the stay.
In Ostano Commerzanstalt v. Telewide Sys., Inc., 790 F.2d 206 (2d Cir. 1986), the Second Circuit explained that “although the debtor is currently the appellant, this action is stayed because it was originally brought ‘against the debtor’.” Ostano Commerzanstalt, 790 F.2d at 207. Interestingly, the case involved a situation where the defendants-appellants filed bankruptcies after oral argument before the Court of Appeals but prior to that Court’s issuance of an opinion. Id. Although the debtors/defendants-appellants expressly agreed with the appellee that the stay did not apply, the Court of Appeals disagreed and expressly noted that “the debtor may not waive the automatic stay” because “the purpose of the stay is to protect creditors as well as the debtor.” Id. Accordingly, the Court of Appeals agreed that “whether an action is ‘against the debtor’ is determined by examining the debtor’s status at the time proceeding were initiated, and not by looking to which party has appealed.” Id. It is important to keep in mind also that the automatic stay may apply where the debtor is a plaintiff, for example, where the debtor/plaintiff is defending itself against counterclaims asserted by the defendant.
As such, regardless of the posture of the parties during the appeal, the best course of action is to make sure that the appellate court is notified of the bankruptcy filing. The appellate court will likely confirm with the appellate parties that the appeal is stayed and direct them to keep the appellate court informed as to the status of the bankruptcy proceeding so that it could proceed with the appeal if and when it is authorized to do so.