The debtors filed for bankruptcy under Chapter 7 of the Bankruptcy Code and failed to disclose all their interests. After the bankruptcy case was closed, the debtors, among other plaintiffs (“the non-debtors”), filed a Kansas state lawsuit (“the Kansas litigation”) against the creditor. The Kansas litigation revealed that the debtors had failed to include Kansas oil and gas interests in their bankruptcy schedules. The creditor moved to reopen the bankruptcy case, the bankruptcy court granted the creditor’s motion, and the automatic stay went into effect. The debtors continued the Kansas litigation until the bankruptcy trustee successfully moved to stay the entire Kansas litigation. The non-debtors and non-creditor defendants (together, “the non-bankruptcy parties”) moved to modify the automatic stay, which the bankruptcy court denied because the parties failed to show cause and the bankruptcy estate’s property interests were “hopelessly intermingled with the [non-debtor’s] claimed interests” in the Kansas litigation. However, the debtors’ filings and prosecution in the Kansas litigation continued. The creditors moved in the bankruptcy court for (1) civil contempt sanctions against the debtors; and (2) a discretionary declaration that the Kansas litigation was void ab initio because of the debtors’ undisclosed mineral interests. The bankruptcy court held that the debtors and two of the debtor’s attorneys were in contempt and denied the void ab initio claim for failure to allege a violation of the automatic stay by the non-bankruptcy parties in the Kansas litigation. Around the same time, a settlement was reached between the trustee and the creditor, pursuant to which the trustee transferred all the debtors’ rights in the mineral lease at issue to the creditor in exchange for the creditor releasing all claims against the bankruptcy estate. After the bankruptcy court approved the settlement, the non-bankruptcy parties moved to determine whether the automatic stay had been terminated due to the estate’s transfer of and relinquishment of the mineral lease interests. The bankruptcy court then signed four orders stating that the stay was no longer in effect with respect to the non-debtors’ claims in the Kansas litigation. It also made clear the non-debtors had not violated the automatic stay, and the Kansas litigation was not void ab initio. The creditors appealed the orders to the district court, which affirmed. Creditors then appealed to the Fifth Circuit.
In Am. Warrior, Inc. v. Found. Energy Fund IV-A, L.P. (In re McConathy), 111 F.4th 574 (5th Cir. 2024), the Fifth Circuit affirmed the bankruptcy and the district court’s judgments. First, the court found that the creditor incorrectly interpreted the scope of the stay. The court held that the lower courts did not err in limiting any violation of the automatic stay to the debtor and its counsel. The court echoed the bankruptcy court’s distinction in the Kansas litigation between the claims against the debtors, which were invalid, and the claims of the non-debtors, which were merely paused while the estate sorted out the mineral lease rights involved in the claims. The court also stated the creditor’s contention that the Kansas litigation was void ab initio was inconsistent with the creditor’s own behavior because it failed to appeal the bankruptcy’s ruling that recognized the validity of Kansas litigation. Second, the court disagreed with the creditor’s res judicata theory regarding the bankruptcy court’s previous order (“the initial order”), refusing to lift the stay earlier in the bankruptcy case. The creditor argued this initial order was final and barred the debtor from further attempts to lift the stay because the debtor never appealed that initial order. The creditor relied on two Supreme Court cases, but the Fifth Circuit disagreed, explaining the cases would not apply because, taken at face value, they would fundamentally misapply the automatic stay. The Fifth Circuit explained that the bankruptcy code is not a “straitjacket”; therefore, when a party fails to appeal, they are not limited from doing so later. The court disagreed with the contention that because the debtor never appealed that initial order, it became final with prejudice. Next, the court disagreed with the creditor that a formal annulment was required to “retroactively validate” the Kansas litigation. The Fifth Circuit emphasized that it has never held that all actions taken in violation of the automatic stay are automatically void, just that they are voidable. Lastly, the circuit court held it had no jurisdiction to review a permissive abstention given the provisions of 11 U.S.C. § 1334(c)(1).
By Olivia Lewis: [email protected]
Edited By Kristin Meurer: [email protected]
Edited By Hayden Mariott: [email protected]