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The Second Circuit’s Preservation of the Automatic Stay Under the Bankruptcy Code

Daniel Ahmed

The Second Circuit’s Preservation of the Automatic Stay Under the Bankruptcy Code
Photo by Brian Garrity on Unsplash

On July 6, 2022, in Bayview Loan Servicing LLC v. Fogarty (In re Fogarty), the U.S. Court of Appeals for the Second Circuit held that the foreclosure sale of a property violates the automatic stay provisions of the Bankruptcy Code when a tenant, named as a party in the foreclosure action, files for bankruptcy—even if the debtor has a mere possessory interest in the property. The automatic stay under the Bankruptcy Code is a long-standing protection to which debtors are entitled and triggered automatically upon the filing of a petition for relief. In essence, the filing operates as a stay of any type of new or continuing action against a debtor or property of the estate, providing debtors relief from creditors. Answering a question of first impression, the Second Circuit declared a bright-line rule stating that, “so long as the debtor is a named party in a proceeding or action, the automatic stay applies to the continuation of that proceeding, and to the enforcement of, a judgment rendered in that proceeding.”

In Fogarty, the debtor-appellee, Eileen Fogarty, held a 99% interest in 72 Grandview LLC (“Grandview”), the sole owner of Ms. Fogarty’s primary residence in Shirley, New York (the “Property”). Sometime in 2010, Grandview stopped making payments and defaulted on the mortgage and note secured by the Property. The following year, the owner and holder of the loan, appellant, Bayview Loan Servicing LLC (“Bayview”), initiated a foreclosure action in the Supreme Court of New York, Suffolk County. Bayview obtained a judgment of foreclosure and sale in 2018, naming Grandview and Ms. Fogarty as defendants. Subsequently, a foreclosure sale of the Property was scheduled for April 17, 2018. However, four days prior to the foreclosure sale, Ms. Fogarty filed a petition for relief under Chapter 7 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Eastern District of New York. On the eve of the foreclosure sale, Ms. Fogarty’s counsel emailed Bayview, apprising it of her bankruptcy and that proceeding with the foreclosure sale would violate the automatic stay—in which case Ms. Fogarty would seek sanctions. Minutes before holding the foreclosure sale, Bayview’s counsel responded to Ms. Fogarty, stating that since Grandview was a legal entity distinct from Ms. Fogarty, her bankruptcy did not trigger a stay as to actions against Grandview or Grandview’s assets.

Thereafter, Ms. Fogarty moved under 11 U.S.C. § 362(k), and asserted, among other things, that Bayview willfully violated the automatic stay provisions: first, under Section 362(a)(1), for “the commencement or continuation … of a judicial … or other action or proceeding against the debtor,” and second, under Section 362(a)(2), for “the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case.” The Bankruptcy Court denied both motions, reasoning that because Ms. Fogarty could not be held personally liable for Grandview’s default under the loan, Bayview’s foreclosure action was an action solely in rem, as opposed to an action in personam. And for that reason, the Bankruptcy Court found that Bayview did not violate the automatic stay in completing the foreclosure sale.

Ms. Fogarty appealed to the U.S. District Court for the Eastern District of New York. In reversing the Bankruptcy Court’s order, the District Court held that: (1) because Ms. Fogarty was a named defendant in the foreclosure action, which was the basis for the foreclosure sale, Bayview violated the automatic stay, and (2) because the foreclosure sale “significantly lessened the barriers to evicting [Ms. Fogarty] from the Property[,]” the foreclosure sale interfered with Ms. Fogarty’s possessory interest in the Property, which was part of her bankruptcy estate, and therefore, protected by the automatic stay. The District Court also found that Bayview willfully violated the automatic stay because the relevant inquiry under the circumstances required only a determination of whether Bayview intended to take the action that violated the automatic stay—i.e., completion of the foreclosure sale with knowledge of Ms. Fogarty’s bankruptcy. Therefore, the District Court found Ms. Fogarty entitled to actual damages as a sanction against Bayview and remanded the case for a determination of the damages award.

Bayview appealed to the Second Circuit. In a unanimous decision, the Second Circuit affirmed the District Court in a decision authored by Judge Susan Carney, and remanded the case for further proceedings. In doing so, the Second Circuit rejected Bayview’s argument that because the foreclosure action was an “in rem” proceeding and the nature of Ms. Fogarty’s involvement in that action was only that of an “interested party,” the automatic stay did not apply to the foreclosure sale. The Second Circuit found this argument fundamentally flawed, and noted that Section 362(a) “draws no textual distinction between in rem and in personam proceedings in which the debtor is a named party, nor does it inquire into why the debtor was named as a defendant in an action or proceeding.” The Second Circuit cited to the plain text of Section 362(a), stating again that “any action or proceeding ‘against the debtor’ is stayed, regardless of whether the debtor was purportedly named as merely an interested or nominal party or as some other kind of defendant.”

Relying on various precedents from within the Second Circuit, Bayview argued that the foreclosure sale did not affect Ms. Fogarty’s bankruptcy estate, whether looking to Section 362(a)(1) or (a)(2), because any effect of the sale on her possessory interest in the Property was far from a legal certainty and therefore did not violate the stay. However, the Second Circuit found Bayview’s reliance on these precedents to be misplaced. It distinguished the cases on grounds that they involved actions or proceedings against only third parties. Accordingly, the Second Circuit found it unnecessary to resolve the extent to which the foreclosure sale “would have a ‘likely’ or a ‘certain’ effect on Fogarty’s estate.” Rather, the inclusion of Ms. Fogarty as a named party defendant, without more, “subjected the Foreclosure Action to the automatic stay regardless of its precise effects, equitable or legal, on her estate.”

And the Second Circuit rejected Bayview’s argument that under the circumstances, its path to relief, i.e., seeking and obtaining stay relief from the bankruptcy court, was illusory. Specifically, Bayview argued that it would not have been permitted to seek stay relief, as it was not Ms. Fogarty’s direct creditor “and therefore, under [the Second Circuit’s] decision in In re Comcoach, it would not be considered a qualifying ‘party in interest’ under Section 362(d).” Acknowledging the confusion associated with its decision in Comcoach), the Second Circuit clarified that its conclusion there was based in part on the fact that the state foreclosure action was not subject to the stay triggered by Comcoach’s bankruptcy filing, as Comcoach was not a named defendant. Accordingly, “[u]ntil the debtor is named as a party defendant, … the action does not affect the bankrupt estate.” The court noted that the bank had no direct claim against Comcoach, the debtor in the relevant bankruptcy proceeding, but rather, had only rights that were entirely derivative of the mortgagee’s rights (as Comcoach’s landlord). The Second Circuit found that Comcoach is inapplicable here, since unlike the debtor in Comcoach, Ms. Fogarty was named a party defendant in the foreclosure action. Furthermore, since Bayview sought to assert its own rights as a party in interest, the Court found that as a direct adversary of the debtor in an action that was subject to the automatic stay, Bayview would have qualified as a party in interest under Section 362(d) with standing to seek stay relief.

In sum, the Second Circuit declared that:

As a matter of first impression, we hold that two of the Bankruptcy Code's automatic stay provisions, 11 U.S.C. § 362(a)(1) and (a)(2), are violated by the foreclosure sale of a property when the debtor is a named party in the foreclosure proceedings, even if the debtor's direct interest in the property is only possessory. Accordingly, we conclude that Bayview willfully violated the automatic stay when it completed the foreclosure sale while knowing that Fogarty, a named defendant in the Foreclosure Action, had filed a bankruptcy petition. Bayview could and should have sought relief in advance from the bankruptcy court.

And while the Second Circuit left open the question of whether the foreclosure sale impacted Ms. Fogarty’s possessory interest in the property, under New York law, the Court nonetheless, reconfirmed the importance of the automatic stay as a pivotal source of relief to which a bankruptcy debtor is entitled. In that regard, the Court emphasized that “[t]o the extent that the effects of the automatic stay effects may be inequitable, Congress has provided a means of addressing that concern through Section 362(d)’s provision for relief from the stay.”

This article was prepared by the Business Law Section's Business and Corporate Litigation Committee.