“What is it about the word ‘stayed’ you don’t understand?” asked the Bankruptcy Judge at oral argument.  He was grilling opposing counsel, who had filed a bankruptcy action for his client but nonetheless proceeded afterwards – without ever disclosing that bankruptcy – to take my client’s deposition, make discovery demands and file motions in a long-pending state-court action.  “And why shouldn’t I find that the debtor acted in bad faith and annul the stay?” the Judge asked him next.  “If you wanted to go litigate in state court, you bear the consequences of that.”

We were before the Bankruptcy Court on my client’s motion to lift the automatic stay, and retroactively validate an arbitral award that had been entered post-bankruptcy in favor of my client.  The debtor, on the other hand, insisted that the automatic stay rendered our arbitral award void because it was entered after the bankruptcy had been filed.

Pursuant to 11 U.S.C. § 362, a party in an ongoing litigation may apply to the bankruptcy court for relief from stay for various reasons, including in order to conclude an ongoing action in the interests of efficiency.  See, e.g., In re Curtis, 40 B.R. 795 (Bankr. D. Utah 1984) (describing various grounds and considerations); In re Betzold, 316 B.R. 906 (Bankr. N.D. Ill. 2004) (lifting stay to allow ongoing matter to conclude).

Given the debtor’s own continuing, active prosecution of the state action, we argued that a judicial estoppel arose that barred her from invoking the automatic stay to defend a matter that she had persisted in actively prosecuting offensively.  Judicial estoppel is an equitable doctrine that prevents a party from making inconsistent claims in different proceedings “according to the exigencies of the moment,” New Hampshire v. Maine, 532 U.S. 742, 749 (2001) (quoting United States v. McCaskey, 9 F.3d 368, 378 (5th Cir. 1993)), in order to “protect the integrity of the judicial process,” New Hampshire v. Maine, 532 U.S. at 749–50 (quoting Edwards v. Aetna Life Ins. Co., 690 F.2d 595, 598 (6th Cir. 1982)).  See also, Krystal Cadillac-Oldsmobile GMC Truck, Inc. v. General Motors Corp., 337 F.3d 314 (3d Cir. 2003) (applying judicial estoppel to bar assertion of undisclosed claim in bankruptcy).

As numerous courts evaluating this issue have explained, the purpose of the automatic stay is not implicated in the face of offensive litigation activity by the debtor; rather, “[w]here the debtor has initiated a prepetition lawsuit against a creditor, the same policy considerations do not exist.”  In re White, 186 B.R. 700, 704 (9th Cir. BAP 1995) (citing In re Merrick, 175 B.R. 333, 336 (9th Cir. BAP 1995).

As a result, the § 362 automatic stay “does not prohibit a defendant in an action brought by a plaintiff/debtor from defending itself in that action.”  In re Way, 229 B.R. 11, 13 (9th Cir. BAP 1998); see In re Wheatfield Bus. Park, LLC, 308 B.R. 463, 466 (9th Cir. BAP 2004); White, 186 B.R. at 707; Merrick, 175 B.R. at 336; see also Stanwyck v. Beilinson, 104 Fed. Appx. 616, 618-19 (9th Cir. 2004) (automatic stay does not apply to defense of pre-petition lawsuit brought by debtor).

In Merrick, the debtors had filed a prepetition lawsuit in state court, and the defendants moved for summary judgment.  175 B.R. at 334.  Following the bankruptcy filing, the state court ruled on the unopposed motions, entered judgment in favor of the defendants, and awarded costs against the debtors.  Id. at 335.  The BAP concluded that a § 362 stay does not prevent a defendant from continuing to defend against a pre-bankruptcy lawsuit.  Id. at 336.  The court reasoned that because § 362 “does not stay the hand of the trustee from continuing to prosecute a pre-bankruptcy lawsuit instituted by the debtor,” equitable principles of fairness dictate that a defendant should be allowed to defend himself “without imposing on him a gratuitous impediment in dealing with an adversary who suffers no correlative constraint.”  Id. at 337-38.  As such, the Merrick court held that “the automatic stay should not tie the hands of a defendant while the plaintiff debtor is given free reign [sic] to litigate.”  Id. at 338; see also, In re Way, 229 B.R. at 15 (holding that the defendants did not violate the automatic stay by obtaining dismissal post-petition of a state court action initiated by the debtor prepetition).

Ultimately, the Bankruptcy Court handling our matter looked to the case of In re Myers, 491 F.3d 120 (3d Cir. 2007) for guidance.  There, the Third Circuit had ruled that a bankruptcy court may indeed annul the stay retroactively.  In making that determination, the court of appeals instructed bankruptcy courts to consider whether the creditor was aware of the bankruptcy filing, whether the conduct of the debtor was inequitable, and whether the creditor would be prejudiced absent annulment.  Applying those factors in our case, the Bankruptcy Court granted our motion, annulled the stay retroactively, and validated our arbitral award despite the then-ongoing bankruptcy.

The lesson in all this?  The automatic stay means stop litigating.  That applies to debtors as well as creditors, and debtors who continue to litigate after filing for bankruptcy do so at their peril.