When a company files for bankruptcy, they gain a number of protections under federal law.  One of these protections is the “automatic stay” provided by 11 U.S.C. § 362. The automatic stay makes it illegal to continue prosecuting, or to initiate, an action against the debtor who is in bankruptcy.  Even if that debtor has injured you, it means that you cannot try to recover from them without getting the automatic stay lifted.  As more large bankruptcy cases are filed in Delaware, it becomes increasingly important that persons injured by debtors understand the legal hoops that they have to jump through in order to recover for their injuries.

To aid in discussing this matter, imagine a situation in which a person (the “Injured”) is injured when hit by a truck belonging to the company (the “Debtor”).  The Injured files a lawsuit in state court to recover and the Debtor files for bankruptcy protection in Bankruptcy Court for the District of Delaware (“DE Bankruptcy Court”).  The last important assumption is that the Debtor, like most large companies, has insurance that can compensate the Injured.  While many of the principles of this post will apply in other courts, it will be discussed specifically in the context of this purely hypothetical situation.

The Automatic Stay

11 U.S.C. § 362 (“Section 362”) provides that, with limited exceptions, when the Debtor files for bankruptcy, a stay is placed on actions that could otherwise be brought against it.  Section 362 includes prohibitions against nearly any legal action that could be brought against the Debtor in any court other than the DE Bankruptcy Court.  While there are exceptions, they are very specific and beyond the scope of this post.  Rather, this post will focus on what a person who was injured by a Debtor should do in order to obtain a recovery.

The specific provisions of Section 362(a) which relate to our example are as follows:
“[A] petition filed under … this title … operates as a stay … of –
(1) the commencement or continuation  … of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;
(3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;

Thus, the Injured will find it very difficult to recover, since they are prohibited from bringing a new lawsuit against the Debtor or continuing to prosecute the lawsuit that has already begun.  In some instances, a Debtor will declare bankruptcy days before a trial is scheduled to begin, freezing any litigation against it.  While this is certainly frustrating for the Injured, there is a path to obtain recovery.

Relief from the Automatic Stay

In order to resume an existing lawsuit against the Debtor, or start a new lawsuit against the Debtor, the Injured must obtain relief from the automatic stay.  This requires the Injured to file a motion for relief from stay and the judge presiding over the bankruptcy to grant the motion.

The relevant language from the Bankruptcy Code is found in Section 362(d), which provides in pertinent part as follows:
(d) On request of a party in interest and after notice and a hearing, the court shall grant relief from the stay provided under subsection (a) of this section, such as by terminating, annulling, modifying or conditioning such stay –
(1) for cause, including the lack of adequate protection of an interest in property of such party in interest.

Thus, the DE Bankruptcy Court is required to determine if there is “cause” to lift the stay.  In making that determination, the DE Bankruptcy Court follows the analysis of the case Izzarelli v. Rexene Prods. Co. (In re Rexene Prods. Co.), 141 B.R. 574, 577 (Bankr. D. Del. 1992).  The DE Bankruptcy Court places the initial burden on the Injured to establish that cause exists, and allows the Debtor an opportunity to rebut the Injured’s argument.

In the Rexene opinion, the DE Bankruptcy Court cites to the legislative history of Section 362 in its holding that ‘It will often be more appropriate to permit proceedings to continue in their place of origin, when no great prejudice to the bankruptcy estate would result, in order to leave the parties to their chosen forum and to relieve the bankruptcy court from any duties that may be handled elsewhere.’  Rexene Prods., 141 B.R. at 576 (quoting H.R. Rep. No. 95-595, 95th Cong., 1st Sess., 343-344 (1977)).

The DE Bankruptcy Court has adopted a three-prong analysis to determine whether there is cause to grant relief from the automatic stay.  The court determines whether (i) any great prejudice to either the bankruptcy estate or the Debtor will result from continuation of the civil suit; (ii) the hardship to the Injured by maintenance of the stay considerably outweighs the hardship to the Debtor; and (iii) the Injured has a probability of prevailing on the merits.

A bankruptcy estate generally is not considered to have an interest in proceeds of liability insurance policies.  Consequently, the DE Bankruptcy Court typically holds that a Debtor does not suffer prejudice or hardship if the Injured obtains stay relief to liquidate claims that are covered by such proceeds.

With respect to the third prong of the analysis regarding cause, the DE Bankruptcy Court held in Rexene that the required showing is very slight.  The threshold for this third prong is even easier to meet where a movant’s claim would be covered by non-debtor sources. In cases following Rexene, the DE Bankruptcy Court has stated that under such circumstances, a bankruptcy court should not examine the merits of the movant’s claims. Rather, “all that is required is that the movant make more than a ‘vague initial showing’ that he can establish a prima facie case. In a case, [sic] such as this one where the claimant seeks only to liquidate its claims as a predicate to recovering against insurance and other non-debtor sources, to require a merits analysis would defeat the objective of economizing judicial resources and would frustrate the effort to resolve relief from stay motions expeditiously.” Santa Fe Minerals v. BEPCO. L.P. (In re 15375 Memorial Corp.), 382 B.R. 652, 691 (Bankr. D. Del. 2008).

In deciding whether to lift the automatic stay, the Delaware Bankruptcy Court has also considered general policies, including: 1) whether relief would result in a partial or complete resolution of the issues; 2) lack of any connection with or interference with the bankruptcy case; 3) whether the debtor’s insurer has assumed full responsibility for defending it; 4) whether the parties are ready for trial in the other proceeding; and 5) impact of the stay on the parties and the balance of the harms.  While these issues may provide additional support for the motion for relief from stay that the Injured will need to file, the DE Bankruptcy Court will typically consider them within the context of the Rexene analysis, so attorneys for the Injured should always consider the Rexene factors first.

Finally, 28 U.S.C. § 157(b)(5) provides that Personal Injury and Wrongful Death claims shall be tried in the district court.  Thus, even if a bankruptcy court wanted to decide a personal injury matter, such a case cannot be tried in the bankruptcy court.  I have had the opportunity to observe, on multiple occasions, the judges of the Delaware Bankruptcy Court tell debtors’ counsel that they will not decide personal injury matters.  And while past performance is no guarantee of future results, it does provide a level of predictability here in Delaware.