The automatic stay always applies if debtor is named as a defendant

The Second Circuit recently announced a bright-line rule about the triggering of protections afforded by the bankruptcy Automatic Stay, holding that as long as the debtor is named as a party in a lawsuit, such as a foreclosure, the automatic stay applies to any attempted continuation of the lawsuit, and to the enforcement of any judgment previously rendered in the lawsuit.

The case of In re Fogarty, 39 F.4^th 62 (2d Cir, 2022) involved a debtor who was the 99% owner of an LLC that owned the home that was debtor’s principal residence.  There was a mortgage encumbering the home, but debtor had no personal liability on the mortgage.  The LLC defaulted on the mortgage and a foreclosure was commenced, naming as defendants the LLC and (eventually) the debtor, as a “co-tenant in possession of a portion of the mortgaged premises”.  A Judgment of Foreclosure and Sale was obtained, but the debtor filed for bankruptcy relief on the eve of the scheduled foreclosure sale.  The lender nevertheless proceeded with the sale as scheduled, resulting in debtor’s residence being sold at auction to a third party. A few weeks thereafter the debtor moved for sanctions against the lender in the bankruptcy court. Invoking 11 USC § 362(k), debtor sought actual damages, costs, attorney’s fees, and punitive damages based on the lender’s decision to proceed with the sale.

The Second Circuit determined that debtor’s possessory interest in the home was part of her bankruptcy estate and, as such, was protected by the automatic stay.  The Court found the foreclosing lender guilty of multiple violations of the automatic stay, as follows:

• The foreclosure sale amounted to a “continuation” of a lawsuit commenced against the debtor prior to the bankruptcy filing, in violation of 11 USC 362(a)(1); and
• The foreclosure sale amounted to “enforcement” against the debtor of a judgment obtained prior to the bankruptcy filing, in violation of 11 USC 362(a)(2).

The Second Circuit rejected the lender’s argument that there was no stay violation because it was only an in rem proceeding with the debtor being named as a defendant in their lawsuit as an interested party only, and that the auction sale did not result in a diminution of debtor’s bankruptcy estate.  The court took a very literal ruling of the controlling statutes and held that:

• Any action or proceeding “against the debtor” was subject to the automatic stay;
• The debtor’s precise role in the foreclosure lawsuit did not matter as long as she was a named defendant; and
• The foreclosure action was subject to the automatic stay regardless of whether the sale resulted in a diminution of debtor’s bankruptcy estate or in any way impacted bankruptcy estate property.

The Second Circuit directed the Bankruptcy Court to determine the amount of actual damages owed and to determine whether punitive damages should be imposed.