Submission of proposed order post-petition on state court ruling made pre-petition violates stay subjecting counsel to sanctions

Judge Specie in Pensacola, Florida sanctioned counsel for a creditor in a Subchapter V chapter 11 case for submitting a written order on the request of a state court judge substituting their client for the debtor in a pending lawsuit.  The background was a stipulated deficiency judgment against the debtor by NWE165, LLC in the amount of $300,000, which judgment was then assigned to 4 Dakota.  Subsequent to that judgement, debtor sued Schwizer for over $1.5 million asserting a failure to perform under a purchase and sale agreement.  On 15 January 2021 the district court entered an order of execution assigning to 4 Dakota all of debtor’s  right, title and interest in and to the Schwizer lawsuit.  This order provided that it would operate as a full and complete assignment giving 4 Dakota standing to seek substitution as the plaintiff in such lawsuit.

4 Dakota filed the substitution motion on 20 January 2021, and the state court held a hearing on the motion on 5 March 2021, taking the matter under advisement.  On 7 March 2021 the debtor filed for relief under chapter 11, listing 4 Dakota as a creditor, and filed a suggestion of bankruptcy in the Schwizer lawsuit.  On 18 April the judicial assistant to the state court judge emailed counsel requesting an order granting the motion to substitute counsel.  Counsel for 4 Dakota submitted a proposed order on 23 April, which was signed on 27 April at 1:08pm.  At 1:30 p.m. Debtor’s counsel objected to the substitution order by calling and emailing the state judge, noting their opinion that the order violated the bankruptcy automatic stay.  4Dakota’s attorneys immediately filed a reply disagreeing that the order violated the stay, rather being a ministerial act related to a prepetition hearing.  Debtors filed for sanctions on 29 April.

Judge Specie held a hearing on 4 May finding that the substitution order was void ab initio, given the debtor’s bankruptcy estate’s interest in the Schwizer lawsuit.  Further, that the submission of the substitution order was an act to obtain or exercise control over the lawsuit in violation of 11 U.S.C. 523(a)(3).  Debtor filed a motion to vacate the substitution order which 4 Dakota responded to on 11 May, which response did not mention the court’s ruling from May 4.

Judge Specie noted the underlying regime for sanctions for violation of the automatic stay.  11 U.S.C. §362 prohibits the enforcement of a prepetition judgment against the debtor or its property, and any act to obtain possession or control over such property.  While 11 U.S.C. 362(b) sets for certain exceptions to the automatic stay, unless the action falls into one of the exceptions or the party obtains relief from the stay, the code requires that an individual injured by any willful violation of a stay shall recover actual damages, including costs and attorney fees, and in appropriate circumstances, punitive damages.

The test on whether a violation is willful is whether the offending party 1) knew the automatic stay was invoked, and 2) intended to commit the actions which violated the stay.   Knowledge that a bankruptcy petition has been filed satisfies the first requirement.  The intention requirement does not require specific intent to violate the automatic stay, but rather that the act itself was committed deliberately, even if acting on advice of counsel.  Rather than seeking relief from the bankruptcy court prior to submitting the substitution order, counsel for 4 Dakota submitted the order knowing the state court judge had not decided whether to enter such order prior to the filing of the bankruptcy petition.  The opposition to the Debtor’s request to vacate the order constituted a further violation.

The subjective belief of counsel that the act was solely a ministerial act rather than a violation of the stay does not protect them.  Judge Specie cited the case In re Sanders¹  for support for this proposition.  In Sanders counsel for a creditor filed in state court a request to hold the debtor in contempt after filing an appearance in the bankruptcy case.  While accepting that the filing of a contempt motion was a mistake by counsel, the court found that a mistake of law was no excuse, and that the violation was willful.

Judge Specie also cited the In re Lyubarsky² case for the proposition that such sanctions could be awarded both against the creditor and it’s counsel.  These sanctions were based on a demand for $250,000 coupled with a threat by counsel during settlement negotiations, subjecting counsel to compensatory damages for emotional distress, fees, costs, and punitive damages.

Judge Specie also expressed skepticism that that counsel truly believed that submission of the substitution order was a ministerial act, given that no ruling on the motion in the state court had been made as of the filing of the case, rather that the state court judge had to deliberate and exercise judicial discretion post-filing as to the motion.  Judge Specie rejected the case cited by 4 Dakota, Shakhrani v Escala³ given that in that case the court announced a ruling from the bench prior to the bankruptcy filing, and counsel had submitted the order after receiving notice that the bankruptcy had been dismissed, and before receiving notice that such case had been reinstated.

While a ministerial act is an exception to the automatic stay, many courts have held that entry of a written order, even if it mirrors a prepetition oral ruling from the bench, is not ministerial because it still requires some degree of judicial discretion.⁴

The court reserved ruling as to the damages to be awarded.

1 In re Sanders, Case No. 8:20-bk-02731-RCT, 2020 Bankr. LEXIS 2840, 2020 WL 6020347 at *1 (Bankr. M.D. Fla. 15 Sept. 2020).^↩

2 In re Lyubarsky, 615 B.R. 924, 928 (Bankr. S.D. Fla. 2020).^↩

3 Shakhrani v. Escala, Case No 05-cv-4746(PGS), 2006 U.S. Dist. LEXIS 57294, 2006 WL 2376746 (D.N.J. 16 Aug 2006).^↩

4 See, e.g., In re Fontaine, 603 B.R. 94, 107 (Bankr. D.N.M. 2019) (state court’s entry of foreclosure judgment postpetition based on a prepetition ruling was not ministerial where judge had to review debtor’s objection to the form of the judgment); GemCap Lending I, LLC v. Bateman (In re Naturescape Holding Grp. Int’l, Inc.), Case No. 16-00982, 2018 Bankr. LEXIS 3062, 2018 WL 5099706, at *14 n.85 (Bankr. D. Haw. Oct. 2, 2018) (disagreed with a state court’s ruling that entry of an order was post-petition was ministerial because “a judge is always free to enter a written order that varies from the oral ruling.”); Corbett v. Kiraz (In re Kiraz), Case No. 11-35743-tmb7, Adv. No. 11-03294-tmb, 2012 Bankr. LEXIS 1595, 2012 WL 1120379, at *2 (Bankr. D. Or. Apr. 3, 2012) (written final judgment entered post-petition was not a ministerial act because “the trial court judge retained the discretion to alter his oral ruling in any way he saw fit.”).^↩