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Creditor Claims that Bankruptcy Court Ruling Affects Pending State Court Litigation

When a debtor files a bankruptcy petition, the automatic stay prevents any pending litigation involving the debtor from moving forward. 11 U.S.C. § 362. Once a bankruptcy case is closed, or once a bankruptcy judge lifts the automatic stay, pending lawsuits and other proceedings may continue. A creditor in a California bankruptcy case recently raised a concern about the effect of an order from the bankruptcy court on a state court lawsuit that was still subject to the automatic stay. The legal doctrine of res judicata holds that once a court has made a final ruling on the merits of a specific claim or issue, that issue cannot be relitigated. The district court, hearing the creditor’s concern on appeal, held that the question of whether res judicata applies must be left to the state court. Restoration Homes, LLC v. Taniguchi, No. 3:15-cv-00032, order (N.D. Cal., Aug. 7, 2015).

The debtor and his wife purchased real estate in 2004. He obtained a mortgage loan modification in 2009, which lowered the total balance and the monthly payments, deferred part of the balance, and adjusted the annual interest rate. In June 2013, the creditor bought the debtor’s loan. It initiated foreclosure proceedings that October, claiming that the debtor had not made payments since July. The debtor disputed this and filed suit to enjoin the foreclosure in California state court. The court granted the debtor’s injunction, on the condition that he post a $40,000 bond. The debtor filed for bankruptcy, since he could not afford the bond.

The creditor’s proof of claim included over $53,000 in prior defaults, $47,000 in payment shortfalls, and other costs and charges. The debtor objected, claiming that the proof of claim was based on the original loan, not the 2009 loan modification. The bankruptcy court partly sustained the objection, ruling that the debtor could cure the default based on the loan modification provisions. The court’s order included a paragraph stating that the order was “without prejudice” to any “claims or defenses” in the state court case, specifically including the amounts owed to the creditor. Taniguchi, order at 3.

The creditor appealed, arguing that this paragraph improperly prevented it from asserting res judicata in state court. Res judicata works in two ways. “Claim preclusion” prevents a party from relitigating a cause of action once they have been subject to a final judgment on that same claim, based on the same set of facts. “Issue preclusion,” also known as “collateral estoppel,” prevents a party from relitigating a fact issue if a court has ruled on that issue in a case to which they were a party. Here, the creditor argued that the “without prejudice” language would prevent it from arguing in state court that the bankruptcy court’s ruling precluded the debtor from disputing the amount of the debt.

The district court noted that it did not share the creditor’s interpretation of the order, finding that it did not prevent any particular legal argument in state court. It also noted that a bankruptcy court lacks the authority to direct the actions of a state court and that the bankruptcy court was deciding a different issue than any issue before the state court. It affirmed the bankruptcy court’s order, holding that the state court retains authority to decide whether res judicata applies.

Since 1997, bankruptcy attorney Devin Sawdayi has represented individuals and families in the Los Angeles area in Chapter 7 and Chapter 13 bankruptcies. Contact us online or at (310) 475-9399 today to schedule a free and confidential consultation with an experienced and skilled financial advocate.

More Blog Posts:

Los Angeles Court Affirms Penalties for Willful Violation of Automatic Stay in Chapter 13 Bankruptcy Case, Los Angeles Bankruptcy Lawyer Blawg, September 18, 2015

Bankruptcy Court Considers Whether to Lift Automatic Stay for Foreclosure-Related Proceedings, Los Angeles Bankruptcy Lawyer Blawg, May 11, 2015

Violation of Automatic Stay Can Result in Emotional Distress and Punitive Damages, According to Ninth Circuit Ruling, Los Angeles Bankruptcy Lawyer Blawg, April 12, 2015