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Bar News - July 16, 2014

Federal Practice & Bankruptcy: Litigators Beware: Post-Bankruptcy Non-Action Could Lead to Severe Penalties

Even a passive violation of the automatic stay or discharge injunction in a bankruptcy case can result in steep monetary penalties, including attorney’s fees and costs, against both the client and the attorney.
The stakes are high in bankruptcy court, even for those lawyers who don’t practice bankruptcy law.

An attorney not knowledgeable about the automatic stay or discharge injunction in bankruptcy could suffer serious consequences. A violation of the stay or injunction can result in steep monetary penalties, including attorney’s fees and costs, against both the client and the attorney.

An attorney who does not litigate within the realm of bankruptcy law may have the impression that the court will have leniency when it comes to these violations. That is not the case, as a recent decision by Chief Bankruptcy Court Judge Bruce Harwood illustrates. The court found a violation even when no affirmative act to collect a debt was taken by the creditor after he received notice of the bankruptcy. The opinion highlights the need to strictly comply with the limitations imposed by the automatic stay and discharge injunction, and to take affirmative steps to halt any proceedings in other courts.

In general, the filing of a bankruptcy petition results in an automatic stay prohibiting any attempt to collect a debt other than through the bankruptcy tribunal. When the bankruptcy proceeding concludes, the bankruptcy court issues a discharge injunction, essentially continuing the automatic stay against most pre-petition debts. That means a creditor should not try to collect a pre-petition debt from a debtor merely because the bankruptcy proceeding has concluded.

In Stone v. Highlands Fuel Delivery LLC, the creditor commenced a small claims action against the debtor in state court and obtained a judgment prior to the filing of the debtor’s bankruptcy petition. Prior to receiving notice of the debtor’s bankruptcy filing, the creditor filed a motion for periodic payments in the small claims action.

Almost two weeks after filing the motion, the creditor received the debtor’s notice of bankruptcy. The state court then issued orders of notice and service instructions to the creditor in relation to the hearing on the motion for periodic payments. Having received the notice of bankruptcy, the creditor did not serve the debtor with the orders of notice and did not attend the hearing.

The creditor did not take any further affirmative action, but as Judge Hardwood explained in his opinion, it made no difference. What eventually became the downfall for the creditor was that the creditor’s counsel neither withdrew the motion for periodic payments, nor filed any notice of the bankruptcy in the small claims action. As a result of the state court’s lack of knowledge regarding the bankruptcy proceeding, that court eventually issued a bench warrant against the debtor (which was subsequently vacated), even though the debt at issue had already been discharged by the bankruptcy court.

Even when a debtor receives a discharge, the debtor still has the ability to seek damages in the bankruptcy court for violation of the stay or discharge injunction. For this reason, in Stone, the debtor’s counsel filed a motion to reopen debtor’s bankruptcy case to pursue the creditor. The parties brought cross-motions for summary judgment, to determine whether the creditor’s failure to withdraw its pre-petition motion violated the discharge injunction.

The creditor argued that there was no violation because, after receiving notice of debtor’s bankruptcy proceeding, no steps were taken to collect on the judgment. The creditor did not even serve the debtor with notice of the hearing on the motion for periodic payments. Judge Harwood did not agree, stating that “[w]hat is relevant is that the process that [creditor] set in motion – and which [creditor] knew was still in motion after it became aware of the debtor’s bankruptcy and the Discharge Order – resulted in [the issuance of a bench warrant], and the Debtor becoming aware of its issuance.” He pointed out that a discharge injunction prohibits the commencement or the continuance of an action. Therefore, “[i]f one is enjoined from continuing a judicial proceeding against the debtor, one is obliged to discontinue it.” For these reasons, the creditor was found in violation of the discharge injunction.

The damages hearing has not been held to date, but Judge Harwood will use his contempt power under Section 105(a) to order monetary relief for the violation of the discharge injunction. Judge Harwood’s opinion should be a reminder to all litigants that an automatic stay or a discharge injunction will reach every court across all jurisdictions. Creditors and their counsel should always be vigilant in determining what action, or non-action, will be viewed as a violation. Any failure to heed such warnings can result in steep monetary damages against client, attorney or both.

Colin Maher is a member of Devine Millimet’s litigation department, concentrating his practice in the area of general commercial litigation. He also practices family law and is a member of Devine Millimet’s bankruptcy and creditor’s rights practice group.

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