The Equitable Exception to the Automatic Bankruptcy Stay

Many defendants facing foreclosure stave off a sheriff's sale by filing a bankruptcy petition before the scheduled sale, thereby invoking the Bankruptcy Code's automatic stay provisions.¹  However, there may be circumstances under which a foreclosure court may reject the bankruptcy stay's applicability to the foreclosure. In Bank of America vs. Williams², Ohio's eighth district court of appeals issued a decision on August 10, 2017, illustrating the application of an "equitable exception" to the automatic bankruptcy stay.

While the foreclosure case was pending, the defendant filed a Chapter 7 bankruptcy petition. The plaintiff obtained the bankruptcy court's order granting relief from the stay, and the foreclosure court reactivated the foreclosure case. After the defendant failed to respond to the plaintiff's amended complaint, the court entered a default judgment and ordered a sale.

Thereafter, the defendant filed a second bankruptcy petition, this time under Chapter 13 of the Code. The bankruptcy court dismissed this bankruptcy case, and imposed a sanction by prohibiting another bankruptcy filing within two-years, unless the defendant first obtained the bankruptcy court's permission.

The defendant then transferred a one-half interest in the property to his mother, who was not a party in the foreclosure case. The mother filed her own bankruptcy petition about an hour after the gavel fell at the foreclosure sale. The defendant then filed motions in the foreclosure case seeking an order vacating the sale. He argued that because his mother owned an interest in the property, her bankruptcy filing invoked the automatic stay, and therefore, the sale should be deemed void.  

The plaintiff argued that the defendant's transfer of the one-half interest in the property to his mother and the mother's bankruptcy filing were an improper attempt to circumvent the bankruptcy court's two-year filing restriction. In addition, the plaintiff noted that the mother’s bankruptcy petition stated she had no interest in any real estate.

The foreclosure court denied the motions to vacate the sale and entered an order confirming the sale. The defendant appealed, arguing that the automatic stay should have been deemed effective and that the motions to vacate the sale should have been granted.

The court of appeals affirmed the trial court's decision, holding that the mother's bankruptcy filing did not invoke the automatic stay. First, she had acquired her interest in the property while the foreclosure case was pending, and therefore, was barred by the lis pendens statute, which states, "While pending, no interest can be acquired by third persons in the subject of the action, as against the plaintiff's title."³ Second, the mother's bankruptcy petition stated she had no ownership interest in real estate. Third, even if the automatic stay were applicable, the foreclosure court entered the order confirming the sale after the mother's bankruptcy was dismissed⁴, at which time any stay was no longer in effect. Although these reasons were sufficient to dispose of the appeal, the court further observed that the facts of the case would warrant the application of an equitable exception to the automatic stay. This exception applies in limited circumstances when required in the interests of justice. Quoting prior case law⁵,  the court stated, "In the limited case where an equitable exception is found to apply, the automatic stay provision is inapplicable and a trial court retains jurisdiction to proceed in the matter. In such circumstances, there is no violation of the automatic stay; the trial court's judgment is neither void nor voidable."

The court found that the defendant's repetitive bankruptcy filings, both directly and through his mother's filing, were attempts to use the stay unfairly as a shield to avoid an unfavorable result. The court found that these facts constituted the extreme circumstance contemplated by law that would allow an equitable exception to the automatic stay. According to the court, "To hold otherwise and permit the automatic stay provision to be used as a trump card played after an unfavorable result was reached in state court, would be inconsistent with the underlying purpose of the automatic stay."

This case demonstrates that although many courts liberally apply the automatic stay, an exception may apply in the interest of justice.

Click here for a copy of the court of appeals' decision.

For more information, please contact Larry R. Rothenberg, Esq. Mr. Rothenberg is an attorney with more than 35 years of legal experience who has been recognized by Martindale-Hubbell as a leader in his field, and has been selected in multiple editions of Ohio Super Lawyers. He is a shareholder in Weltman’s Real Estate Default Group in Cleveland, Ohio.
 

¹Bankruptcy Code § 362(a); 11 U.S.C. § 362(a).
²2017-Ohio-7166
³ORC 2703.26.
⁴The bankruptcy court dismissed the mother’s bankruptcy case for an unrelated reason.
⁵JDI Murray Hill, LLC v. Flynn Properties, LLC, 2011-Ohio-301, 8th Dist.