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California Federal Court Rules on Creditor’s Motion to Abstain from Hearing State-Law Claims in Chapter 7 Bankruptcy

The U.S. Constitution gives the federal government authority over bankruptcy, and bankruptcy cases proceed in the federal court system based on federal statutes, regulations, and rules. Bankruptcy courts frequently have to deal with state-law issues, however. This is known as “permissive abstention.” Federal law allows bankruptcy courts to abstain from hearing state-law matters for various reasons. A creditor in a Los Angeles bankruptcy proceeding moved for the bankruptcy court to abstain from hearing issues involved in a lawsuit pending in state court. The bankruptcy court denied the motion, but the district court reversed this order after reviewing the factors courts should consider in a motion to abstain. In re Roger, No. 5:15-cv-00087, order (C.D. Cal., Nov. 24, 2015).

U.S. district courts have jurisdiction over bankruptcy cases, but they are permitted to refer these cases to bankruptcy judges. 28 U.S.C. § 157(a). Bankruptcy courts operate as specialized units of the district courts, and they are authorized to hear most matters arising under Title 11 of the U.S. Code. The permissive abstention statute allows district courts, and by extension bankruptcy courts, to abstain from hearing certain matters if it would be “in the interest of justice” or “in the interest of comity with State courts,” or if it would support “respect for State law.” 28 U.S.C. § 1334(c)(1). The Ninth Circuit has identified 12 factors courts should consider when ruling on permissive abstention, known as the Tucson Estates factors after In re Tucson Estates, 912 F.2d 1162, 1166 (9th Cir. 1990).

The motion to abstain in the Roger case involved a long-running lawsuit in a California state court. The debtor had taken out a loan in 2007 and had signed a guaranty agreement for another loan. The bank assigned both loans to the creditor, as the bank’s receiver, in mid-2009. The creditor filed suit against the debtor, in his capacity as the borrower on one loan and the guarantor on the other, in December 2009.

The state court issued a non-final minute order in August 2013, granting summary judgment to the creditor on the claims relating to the debtor’s liability on the loan. Two months later, the debtor filed for Chapter 7 bankruptcy, meaning that the automatic stay halted all proceedings in state court.

The creditor’s motion to abstain specifically related to objections made by the debtor and the trustee to its proof of claim, which alleged a debt in excess of $3.7 million. It argued that abstention was warranted because the state court “has already determined all of the factual and legal issues…in summary adjudication proceedings after four years of state-court litigation.” Roger, order at 6.

The district court, in reversing the bankruptcy court’s order denying abstention, found that the bankruptcy court had incorrectly applied multiple Tucson Estates factors. These included whether abstention would support “efficient administration of the estate,” id. at 11; “the degree of relatedness…of the proceeding to the main bankruptcy case,” id. at 16; and “the burden of the bankruptcy court’s docket,” id. at 18.

Bankruptcy attorney Devin Sawdayi has represented Los Angeles individuals and families in Chapter 7 and Chapter 13 bankruptcy cases for the past 18 years, helping them repair their finances with respect and dignity. To schedule a free and confidential consultation with a knowledgeable financial advocate, contact us today online, at (310) 475-9399, or at (800) 474-6050.

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