A Creditor May Recover Damages for Stay Violation

By: Jacquelyn L. Mascetti
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
 
Recently the Fifth Circuit, in St. Paul Fire & Marine Ins. Co. v. Labuzan,[1]expanded the definition of “individual” in 362(k) to include creditors as parties able to bring an action for a violation of the automatic stay. Debtor, Contractor Technology, Ltd. (“CTL”), construction company owned by the Labuzans. St. Paul Fire & Marine Ins. Co. (“St. Paul”), the insurer, issued performance and payment bonds on behalf of CTL for its ongoing projects as insurance for the projects owners in case CTL was unable to complete construction. The Labuzans entered into an indemnity agreement with St. Paul and agreed to be held liable if St. Paul had to pay the bonds to the project owners. After facing some financial difficulty, CTL decided to reorganize and voluntarily filed chapter 11. Shortly thereafter, St. Paul contacted the owners of CTL’s current projects and threatened to reduce the bond insurance on the projects if the owners made any payments to CTL for any work done towards the completion of the project.[2] Caving to the threats, the project owners stopped sending payments to CTL, which drained its remaining assets to pay expenses, and forced the company to convert its proposed reorganization into chapter 7 liquidation.
 
St. Paul paid the project owners according to the bonds on behalf of CTL for the incomplete construction projects, and then sued the Labuzans in the District Court for the Southern District of Texas for a breach of their indemnity agreement. In the meantime, the Labuzans, in the bankruptcy court, claimed that St. Paul violated the stay by threatening the project owners which eventually prevented CTL from successfully reorganizing.[3] The district court consolidated the cases, and in addressing the stay violation, held the Labuzans did not have standing to raise the stay violation issue because they were owners of CTL, and CTL was the injured party, not the Labuzans. 
 
On appeal to the Fifth Circuit, the Labuzans argued that they met both constitutional and prudential standing requirements to pursue the claim against St. Paul for violation of the stay. The court quickly disposed of the constitutional issue by stating the Labuzans’ injuries were sustained as a “result of CTL’s failure to reorganize,” which are “fairly traceable” to St. Paul’s violation of the stay by contacting the owners, and those injuries were “likely to be redressed by a favorable decision.”[4] More importantly, the court also determined the Labuzans had prudential standing as creditors—but not owners—to raise the issues of a stay violation.[5] 
 
Traditionally, prudential standing for stay violations had been satisfied by debtors in possession and trustees because their “grievance[s] arguably [fell] within the zone of interests protected by the statutory provision invoked in the suit,” their complaints usually did not raise “abstract questions or a generalized grievance more properly addressed by the legislative branch,” and they were “asserting [their] own legal rights and interests rather than the legal rights and interests of third parties.”[6] The circuit court reasoned that the Labuzans fell within section 362(k), which grants standing to any “individual” injured by automatic stay violations, because the injury sustained as a result of the stay violation was neither remote nor generalized and separate from the injuries of CTL; furthermore, the Labuzans were asserting their own legal rights, and therefore, had standing.
 
Section 362(k) states that any individual who is injured by a willful violation of a stay can recover damages.[7] The term “individual” had been previously interpreted to include debtors and creditor corporations.[8] Prior to this decision, no court had permitted individual creditors to have standing to bring a 362(k) motion. In deciding “individual” applied to creditors, the court explained that section 362 must be read in conjunction with section 1109,[9] which describes who can appear and be heard on issues in a bankruptcy case, and section 541,[10] which describes the bankruptcy estate. The circuit court determined permitting an individual creditor standing under 362(k) does not conflict section 1109—which permits any party at interest to raise, appear and be heard on any issue—and the Labuzans, as creditors of CTL, had standing to bring this stay violation.[11] The circuit court also clarified that generally the trustee alone would have standing to assert a cause of action for the benefit of the estate because section 541 includes, “all legal or equitable interests of the debtor in property as of the commencement of the case.”[12] The court explained this was inapplicable because a stay violation necessarily occurs after the commencement of the case, and therefore standing was not limited to the trustee.[13] 
 

Prior to St. Paul Fire & Marine Ins. Co., it was possible that only the trustee would have brought a stay violation, but might choose not to for financial reasons and therefore in effect, permit a stay violation to occur with no punishment for the violator, and no recourse for the injured parties. Yet now, the Fifth Circuit’s interpretation of “individual” in section 362(k) to include creditors, treats all creditors uniformly by not permitting some stay violations to go unpunished and is in line with the overarching bankruptcy policy of equal treatment of creditors.[14] However, this interpretation may face some trouble in the future if many creditors begin to take advantage of their standing, and may potentially dilute the trustee’s power as the gatekeeper or result in unnecessary, tedious litigation. [15]



[1] St. Paul Fire & Marine Ins. Co. v. Labuzan, 579 F.3d 533 (5th Cir. 2009).
[2] St. Paul Fire & Marine Ins. Co., 579 F.3d at 536.
[3] Id. at 537.
[4] Id. at 539.
[5] Id. at 538–39, 545.
[6] Id. at 539.
[7] 11 U.S.C. § 362(k) (2006).
[8] See Pettitt v. Baker, 876 F.2d 456, 457–58 (5th Cir. 1989) (concluding a private remedy exists for a debtor under 362(k)); United States v. Miller, No. 5:02-CV-0168, 2003 WL 23109906, at *10 (N.D. Tex. 2003) (permitting the United States to bring a stay violation as a creditor); Homer Nat'l Bank v. Namie, 96 B.R. 652, 654 (W.D. La. 1989) (holding a corporate creditor could bring an action for a stay violation).
[9] 11 U.S.C. § 1109(b) (2006).
[10] 11 U.S.C. § 541(a)(1) (2006).
[11] St. Paul Fire & Marine Ins. Co., 579 F.3d at 543.
[12] Id. at 544–45 (discussing § 541(a)(1)) (emphasis added).
[13] Id. at 545.
[14] Hunt v. Bankers Trust Co., 799 F.2d 1060, 1069 (5th Cir. 1986).
[15] See In re Pecan Groves of Arizona, 951 F.2d 242, 245 (9th Cir. 1991). This decision is particularly relevant in the construction industry where the companies are generally small, closely-held partnerships that frequently use indemnity bond notes for insurance, and where these facts are likely to repeat themselves.