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Of all the provisions of the Bankruptcy Code, Section 362 pertaining to the automatic stay appears more straightforward than most. In spite of the apparent simplicity of the statutory language, however, bankruptcy courts continue to referee disputes regarding the boundaries of the stay, and 2017 saw two Third Circuit decisions and one reported New Jersey Bankruptcy Court decision involving the stay. The lesson: be cautious before engaging in post-petition conduct. As the cases below illustrate, violations of the stay can result in damages, including damages for emotional distress and punitive damages.

Post-Petition Construction Lien in NJ Violates the Automatic Stay

In In re Linear Elec. Co., 852 F.3d 313 (3d Cir. 2017), the Third Circuit found that the filing of a construction lien by a subcontractor after the general contractor filed for bankruptcy violates the automatic stay. The holding hinges on New Jersey’s unique construction lien statute, which creates a lien fund for the benefit of unpaid contractors, subcontractors and suppliers, and which does not provide for relation back of a construction lien.

Here, suppliers on a construction project supplied electrical materials, which were incorporated into the project by the general contractor. The owners of the project did not pay the general contractor in full and the general contractor, in turn, did not pay the suppliers. The general contractor filed a voluntary petition under the Bankruptcy Code and, two weeks later, the suppliers filed construction liens on the project. The general contractor challenged the liens as violating the automatic stay.

The Third Circuit examined the New Jersey Construction Lien Law, codified at N.J.S.A. §2A:44A, et seq. The Lien Law allows an unpaid contractor, subcontractor or supplier providing work, services, material or equipment pursuant to a contract to file a lien against the interest of the owner or unit owner of the real property development. Under the Lien Law, the owner can discharge the lien by paying into a lien fund, out of which the claimants recover amounts owed. If, as was the case in Linear Electric, only the subcontractors/suppliers file liens, then they receive the entirety of the funds in the lien fund, and the general contractor receives only a reduction in its accounts receivable.

Under the Lien Law, the value of the lien fund cannot exceed the amount that the owner actually owed the contractor at the time of filing or service. Therefore, payment of subcontractors and suppliers from the lien fund effects a reduction in the accounts receivable of the contractor. When the contractor has filed for bankruptcy protection, its accounts receivable are property of bankruptcy estate. The court reasoned, therefore, that a lien filed by a subcontractor or supplier would have the effect of reducing the property of the estate and, therefore, violates the stay. Furthermore, if the subcontractors had received repayment from the lien fund, less money would be available to the bankrupt contractor to distribute to its estate. Allowing the claim would elevate the subcontractors in priority and they would receive more than they would have received through the estate, thus disrupting the bankruptcy priority scheme.

In its analysis, the court was careful to distinguish New Jersey’s Lien Law from the mechanic’s lien laws in other states, including Pennsylvania. Under the Lien Law, the construction lien is effective from the date of filing. In Pennsylvania, however, mechanic’s liens relate back to the date of commencement of the work. The court noted that relation back may provide an exception to the statute.

Post-Petition, Pre-Discharge Truthful Reporting of Unpaid Debt to Credit Agency Does Not Violate the Stay

In In re Porcoro, 565 B.R. 314 (Bankr. D.N.J. 2017), a case of first impression, the Bankruptcy Court for the District of New Jersey found that a creditor’s pre-discharge, post-petition truthful reporting to the credit agency does not violate the stay. In this case, the creditor was a telephone, cable and internet provider. Prior to the petition date, service on the debtor’s account was suspended by the creditor for non-payment. During the pendency of the case, the creditor reported the past due balance to the credit reporting agencies. On the date the discharge was entered, the creditor reported $0 as due to the credit agencies. The debtor sought sanctions and damages from the bankruptcy court for a violation of the automatic stay.

As the issue was a case of first impression in the Third Circuit, the bankruptcy court reviewed cases decided throughout the country discussing the reporting of debts to credit agencies in the context of violations of the discharge injunction. Id. at 321-26. The bankruptcy court concluded that, as analogous to a violation of the discharge injunction, a creditor making a report to a credit agency with the goal of extracting or collecting payment would be deemed to violate the stay. Id. at 325-26. On the other hand, a mere report with no evidence of harassment, coercion or other link to show that the act is likely to be effective as a debt collection device, would not violate the stay. Id.

In order to steer clear of a stay violation, a creditor’s post-petition report to the credit agencies should, at a minimum: (a) comport with the Fair Credit Reporting Act; (b) be accurate; (c) be free from any coercive actions or other actions designed to, or look like they are designed to, collect the outstanding debt; and (d) be pre-discharge.

Individuals May Recover Emotional Distress Damages for Stay Violations

Section 632(k)(1) of the Bankruptcy Code provides that “an individual injured by any willful violation of a stay … shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.” In Lansaw v. Zokaites, 853 F.3d 657 (3d Cir. 2017), the Third Circuit joined the Eleventh, Ninth and First Circuits in expressly concluding that “actual damages … include damages for emotional distress[.]” Id. at 667.

In Lansaw, the court addressed the recoverability of damages for emotional distress and the evidence required to prove emotional distress damages. There, the plaintiff-debtors operated a daycare business in a building leased to them by the defendant-landlord. At the termination of their lease, the plaintiff-debtors chose not to renew and to move to a new location. The defendant-landlord served plaintiffs with a notice of distraint, and they filed for bankruptcy the next day. What followed was repeated physical intimidation by the landlord in the presence of children. First, the landlord and his attorney visited the daycare during business hours, entered the premises over the protest of the tenant and cornered the tenant, repeatedly asking her whether she wanted to hit him. Then, the landlord chained the building shut and only agreed to allow the tenant to enter under police escort. Later, the landlord demanded that the plaintiffs sign a reaffirmation agreement and waive certain claims against the landlord. When they refused, they returned to the building and the landlord proceeded to lock them inside. Finally, the landlord sent a letter to plaintiffs’ new landlord and demanded that the lease be terminated or the landlord would file suit.

The Third Circuit concluded that Congress intended the automatic stay to protect both pecuniary and non-pecuniary interests. Id. at 666-68. Given the breadth of the interests to be protected, the court found that “it is only logical that Congress would intend to include damages resulting from that harm … [W]e see no reason to infer that Congress intended to distinguish between the pecuniary and non-pecuniary injuries when it adopted a system of compensatory damages” for stay violations. Id. at 668.

To establish emotional distress damages, the plaintiffs introduced testimony regarding the emotional harm suffered as a result of the stay violations, including depression. In determining whether the evidence presented was sufficient, the court noted that the sufficiency of evidence to establish emotional distress varies from case to case. Id. at 669. In some cases, medical evidence or expert testimony may be required. In other cases, however, where the violation of the stay is “patently egregious,” credible testimony by the plaintiff will be sufficient. Id. If, after collection of evidence, the court finds that “a reasonable person in the position of the [plaintiff] would be expected to suffer some psychological harm as a result of what happened,” and the plaintiff introduces credible evidence of such harm, emotional distress damages are available. Id. at 670.  Given the landlord’s egregious conduct, the court found that the plaintiffs’ credible testimony was sufficient to substantiate the emotional distress damages.

Practitioner Pointers

Creditors sometimes knowingly and sometimes unknowingly violate the automatic stay by, for example, sending default or demand letters after the petition date for a pre-petition obligation, recording a lien post-petition or instituting a lawsuit based on pre-petition debts or claims. As the foregoing cases demonstrate, willful violators of the automatic stay may be subject to sanctions or to the assessment of damages in individual cases, including punitive damages for the most egregious violations.

Post-petition action contemplated by a creditor should be closely scrutinized to avoid a violation of the stay and the ensuing litigation. While Section 362(a) of the Bankruptcy Code sets forth a list of violations, as the cases discussed above illustrate, the list is not exhaustive. When considering post-petition action evaluate the following: (a) what is the goal of the post-petition action; (b) whether the action is, or is likely to be viewed as, collecting or attempting to collect a pre-petition debt or claim; (c) whether the action falls within an exception to the stay under Section 362(b), such as actions on a lease that has terminated pre-petition; and (d) in the event of an ambiguity, whether it makes sense to tread cautiously and obtain relief from the stay under Section 362(d).

 

Murphy is a partner with Hyland Levin in Marlton. She concentrates her practice in the areas of business reorganization, loan restructuring, loan documentation and business law.