Opinion ID: 195766
Heading Depth: 2
Heading Rank: 3

Heading: Issues Determined During a 362(d) Hearing

Text: C. Issues Determined During a 362(d) Hearing The Trustee argues that the allowance of a motion for relief from stay does not preclude the later prosecution of a preference action, as a determination of the non-avoidability of a lien under 547 is not, logically or practically, part of a court's decision to grant relief from stay. In support of this position, the Trustee cites the Seventh Circuit's decision of Matter of Vitreous Steel Prods. Co., 911 F.2d 1223 (7th Cir. 1990), and urges us to adopt that court's reasoning. In Vitreous Steel, the appeals court held that a decision to lift the automatic stay pursuant to 362(d) does not preclude the prosecution under 547 of an adversary complaint. Vitreous Steel, 911 F.2d at 1234. The court reasoned that the possible avoidability of a transfer to a creditor under 547 is not an issue proper for adjudication by a court during a hearing -10- on a motion to lift the automatic stay, and accordingly found that the bankruptcy court erred in barring a trustee's preferential transfer claim on collateral estoppel grounds. Id. The Vitreous Steel holding rests on persuasive grounds. First, as the Seventh Circuit noted, it is consistent with the statutory scheme established by 362, and particularly with the purpose of the relief from stay provision of 362(d). Id. at 1232. As soon as a petition in bankruptcy is filed, the automatic stay provisions of 362 take effect, preventing all pre-petition creditors from taking action to collect their debts. In certain situations, such as when a creditor has a security interest in the debtor's property and the value of the collateral is less than the amount of the debt, bankruptcy proceedings may only delay the inevitable result. There may be no reason to make the creditor wait for the distribution of the estate, and indeed, early release of the property may aid administration of the estate by allowing a quicker determination of the amount of an undersecured creditor's claim. Id. at 1231-32. Thus, Congress included the provision for relief from stay under 362(d), allowing bankruptcy courts to lift the stay as to certain creditors if grounds for relief are presented. Id. at 1232; see 11 U.S.C. 362(d). These grounds are the adequacy of protection for the creditor, the debtor's equity in the property, and the necessity of the property to an effective reorganization. 11 U.S.C. 362(d). That the statute sets forth certain grounds for -11- relief and no others indicates Congress' intent that the issues decided by a bankruptcy court on a creditor's motion to lift the stay be limited to these matters. See 11 U.S.C. 362(d). Moreover, the hearing on a motion for relief from stay is meant to be a summary proceeding, and the statute requires the bankruptcy court's action to be quick. Vitreous Steel, 911 F.2d at 1232; see 11 U.S.C. 362(e). Section 362(e) provides that a bankruptcy court must hold a preliminary hearing on a motion to lift the stay within thirty days from the date the motion is filed, or the stay will be considered lifted. A final hearing must be commenced within thirty days after the preliminary hearing. Vitreous Steel, 911 F.2d at 1232 (citing Fed. R. Bankr. P. 4001(a)(2)); see 11 U.S.C. 362(e). The limited grounds set forth in the statutory language, read in the context of the overall scheme of 362, and combined with the preliminary, summary nature of the relief from stay proceedings, have led most courts to find that such hearings do not involve a full adjudication on the merits of claims, defenses, or counterclaims, but simply a determination as to whether a creditor has a colorable claim to property of the estate. See, e.g., Estate Contruction Co. v. Miller & Smith Holding Co., Inc., 14 F.3d 213, 219 (4th Cir. 1994) (hearings to lift the stay are summary in character, and counterclaims are not precluded later if not raised at this stage); Vitreous Steel, 911 F.2d at 1232 (questions of the validity of liens are not at issue in a 362 hearing, but only whether there is a colorable claim -12- on property); In re Johnson, 756 F.2d 738, 740 (9th Cir.), cert. denied, 474 U.S. 828 (1985) (relief from stay hearings are limited in scope to adequacy of protection, equity, and necessity to an effective reorganization, and validity of underlying claims is not litigated); Nat'l Westminster Bank, U.S.A. v. Ross, 130 B.R. 656, 658 (Bankr. S.D.N.Y.), aff'd, 962 F.2d 1 (2d Cir. 1991) (decision to lift stay does not involve determination of counterclaims, and thus those claims are not precluded later); In re Quality Elect. Ctrs., Inc., 57 B.R. 288, 290 (Bankr. D.N.M. 1986) (relief from stay proceedings limited to whether the moving creditor has a colorable claim to a perfected security interest); In re Pappas, 55 B.R. 658, 660-61 (Bankr. D. Mass. 1985) (trustee's counterclaims may be considered, though not adjudicated, at relief from stay proceedings);7 In re Geller, 55 B.R. 970, 974-75 (Bankr. D.N.H. 1985) (although a bankruptcy court may consider counterclaims during a relief from stay hearing, it is not authorized to a res judicata determination of 7 The Bank cites In re Pappas in support of its argument that preference counterclaims are among claims that challenge the validity of a creditor's lien, and thus are part of the relief from stay determination. The Bank's reliance on that case, however, is misplaced. As the Trustee points out, that case involved the unusual factual situation of a creditor trying to prevent a trustee from pursuing a defense to a motion for relief. The Pappas court recognized that while a 362 motion for relief hearing is not the proper forum for deciding counterclaims, a court need not blind itself to such counterclaims, and may consider them where raised. In re Pappas, 55 B.R. at 660-61. The court went on to discuss the distinction between considering and adjudicating such claims, and specifically stated that claims that challenge the validity of a lien will be considered, though not adjudicated, at the hearing on relief from stay. Id. at 661. The Bank somehow overlooked this statement. -13- such claims on their merits); In re Tally Well Serv., Inc., 45 B.R. 149, 151-52 (Bankr. E.D. Mich. 1984) (a court may merely consider counterclaims and defenses at a relief from stay hearing, but such hearing is not the proper proceeding for those claims' adjudication); cf. In re Shehu, 128 B.R. 26, 28-29 (Bankr. D. Conn. 1991) (acknowledging the narrow scope of hearings on relief from stay, but allowing the debtor to present evidence on indirect defenses going to offset the amount of the secured debt, for the limited purpose of determining whether the debtor has equity in the property). These courts' interpretation of 362 also comports with the statute's legislative history: At the expedited hearing under subsection (e), and at all hearings on relief from the stay, the only issue will be the claim of the creditor and the lack of adequate protection or existence of other cause for relief from the stay. This hearing will not be the appropriate time at which to bring in other issues, such as counterclaims against the creditor on largely unrelated matters. Those counterclaims are not to be handled in the summary fashion that the preliminary hearing under this provision will be. Rather, they will be the subject of more complete proceedings by the trustees to recover property of the estate or to object to the allowance of a claim. H.R. Rep. No. 95-595, 95th Cong., 1st Sess. 344 (1977), reprinted in 1978 U.S. Code Cong. & Admin. News 5787, at 6300 (emphasis added). The Senate report reiterates this explanation, but also adds: However, this would not preclude the party seeking continuance of the stay -14- from presenting evidence on the existence of claims which the court may consider in exercising its discretion. What is precluded is a determination of such collateral claims on the merits at the hearing. S. Rep. No. 95-989, 95th Cong., 2d Sess. 55, reprinted in 1978 U.S. Code Cong. & Admin. News 5787, at 5841 (emphasis added). The relief from stay procedures established by the Bankruptcy Rules also point to the limited scope of the hearing. Relief from the stay is obtained by a simple motion, Fed. R. Bankr. P. 4001, and it is a contested matter, rather than an adversary proceeding. Fed. R. Bankr. P. 9014. See Advisory Committee Note to Fed. R. Bankr. P. 7001 ([R]equests for relief from the automatic stay do not commence an adversary proceeding.). In contrast, all actions to determine the validity of a lien, such as a preference action under 547, require full adjudication on verified pleadings, and must be litigated in adversary proceedings. Fed. R. Bankr. P. 7001. To allow a relief from stay hearing to become any more extensive than a quick determination of whether a creditor has a colorable claim would turn the hearing into a full-scale adversary lawsuit, In re Gellert, 55 B.R. at 974, and would be inconsistent with this procedural scheme. We agree with the Trustee's argument that allowing these hearings to become adversary proceedings would also force the untimely, expedited adjudication of complex and critical issues during the early stages of the case, on the basis of the movant creditor's unverified motion for relief. Trustees would -15- be forced to assert (and win) not only objections to motions for relief from stay, but any and all possible defenses and counterclaims to the underlying claims of the movant creditor, or risk being precluded from raising them later. Bankruptcy courts would likewise be forced to determine the validity, priority and extent of a lien during the relief from stay hearing, and the creditor's motion would thus become a substitute for the normal adversary proceedings on the merits. See In re Quality Electronics, 57 B.R. at 290. Moreover, the Bankruptcy Code specifically provides that a trustee has two years after appointment or until the close of the case to commence a 547 preference action. Section 546(a)(1). A relief from stay proceeding, conversely, is usually commenced very shortly after the bankruptcy petition is filed, and, as explained above, must be completed no more than sixty days from the filing of the motion for relief. Forcing trustees to raise their counterclaims within that short period, usually during the nascent stages of a bankruptcy case, would in effect allow movant creditors to drastically reduce the two-year limitations period set forth in the Code. Not only is this result patently unfair and inefficient, it renders the Bankruptcy Code's statutes of limitations provision irrelevant -- a result we cannot endorse. For all these reasons, we find that a hearing on a motion for relief from stay is merely a summary proceeding of limited effect, and adopt the Vitreous Steel court's holding that -16- a court hearing a motion for relief from stay should seek only to determine whether the party seeking relief has a colorable claim to property of the estate. The statutory and procedural schemes, the legislative history, and the case law all direct that the hearing on a motion to lift the stay is not a proceeding for determining the merits of the underlying substantive claims, defenses, or counterclaims. Rather, it is analogous to a preliminary injunction hearing, requiring a speedy and necessarily cursory determination of the reasonable likelihood that a creditor has a legitimate claim or lien as to a debtor's property.8 If a court finds that likelihood to exist, this is not a determination of the validity of those claims, but merely a grant of permission from the court allowing that creditor to litigate its substantive claims elsewhere without violating the automatic stay. This is not to say that bankruptcy courts can never 8 Indeed, the legislative history of 362 suggests this very analogy: [T]he automatic stay is similar to a temporary restraining order. The preliminary hearing [on a motion for relief from stay] is similar to the hearing on a preliminary injunction, . . . . The main difference lies in which party must bring the issue before the court. While in the injunction setting, the party seeking the injunction must prosecute the action, in proceedings for relief from the automatic stay, the enjoined party must move. H.R. Rep. No. 95-595, 95th Cong., 1st Sess. 344 (1977), reprinted in 1978 U.S. Code Cong. & Admin. News 5787, at 6300. -17- consider counterclaims and defenses, including preference counterclaims, during a relief from stay hearing. As several bankruptcy courts have discussed, there is a significant difference between mere consideration of claims and final adjudication on the merits. See In re Pappas, 55 B.R. at 660; In re Gellert, 55 B.R. at 974-75; In re Tally Well, 45 B.R. at 152. Certainly, a court may take into account any matter that bears directly on the debtor's equity, or that clearly refutes a creditor's claim to the property. For example, if a trustee raises a defense to a creditor's claim at the relief from stay hearing, the court need not ignore this defense, but may consider it when deciding whether to lift the stay. If, however, the stay is not lifted, that creditor is not barred forever from seeking payment. It must simply comply with the automatic stay, and wait with the other creditors for the estate's administration. Conversely, if the stay is lifted, the creditor may then prosecute its claim in subsequent litigation. The trustee is not precluded from raising defenses or counterclaims in those subsequent proceedings, because the defense was not fully adjudicated, but only considered, during the preliminary hearing. As a matter of law, the only issue properly and necessarily before a bankruptcy court during relief from stay proceedings is whether the movant creditor has a colorable claim; thus, a decision to lift the stay is not an adjudication of the validity or avoidability of the claim, but only a determination that the creditor's claim is sufficiently plausible to allow its -18- prosecution elsewhere. The Bank nevertheless submits that the Vitreous Steel analysis is flawed, and argues: [A] determination (though not necessarily a final one) as to a creditor's security interest is an integral part of any decision regarding the lifting of the stay . . . if the creditor's security interest can be avoided for any reason, there is no cause to grant the creditor relief from stay because the creditor lacks an interest in the debtor's property. (Emphasis in original). Essentially, the Bank contends that because establishing the validity of a creditor's security interest is an essential element of a relief from stay, the fact that the stay was indeed lifted necessarily implies that the security interest is valid. This argument is meritless for two reasons. First, it ignores the important distinction between the consideration and adjudication of an issue. In a relief from stay hearing, the only issue properly before the court, and thus the only one actually adjudicated, is whether the stay should be lifted because a creditor has shown a colorable claim. Put another way, and employing the preliminary injunction analogy discussed above, a creditor must show a reasonable likelihood that it has a meritorious claim, and the court may consider any defenses or counterclaims that bear on whether this reasonable likelihood exists. If the stay is lifted, however, what has been actually adjudicated is only that the creditor has shown this reasonable likelihood. It is not a ruling on the merits of the underlying -19- claim.9 Second, the Bank's argument also ignores the difference between a void claim or lien, and a valid yet voidable lien. A creditor's valid, perfected security interest in the debtor's property may nevertheless be voidable as a preferential transfer under 547. In re Melon Produce, 976 F.2d at 74 (the creation of a perfected security interest in property is itself a preference, when the perfection takes place during the statutory preference period and other criteria are satisfied). A creditor may therefore have a lien that is sufficient to justify lifting the stay, yet ultimately avoidable by the trustee as a preferential transfer under 547. Thus, the Bank's contention that if the creditor's security interest can be avoided for any reason, there is no cause to grant the creditor relief from stay is simply wrong. The only case that the Bank cites purportedly supporting its argument that a relief from stay proceeding can have preclusive effect on a subsequent counterclaim is In re Monument Record Corp., 71 B.R. 853 (Bankr. M.D. Tenn. 1987). This case, however, is entirely distinguishable. In Monument Record, the creditor and the trustee entered into a specific 9 The Bank also urges us to reject the Vitreous Steel court's rigid rule and adopt a flexible approach which takes unique circumstances into account. We will not, however, overlook Congressional intent, statutory language, and well-settled procedural machinery that all limit the issues properly adjudicated in such hearings. It is perhaps not surprising that the Bank fails to cite any authority for its flexible approach argument, as it lacks any legal or practical basis. -20- agreement, in order to resolve the motion for relief from stay, stipulating that the creditor's security interest was a valid first lien. Id. at 855. The bankruptcy court held that this specific agreement precluded the trustee from challenging in a later adversary proceeding the perfection of the security interest. Id. at 864. We agree with the Trustee that the parties' express agreement was the crux of the Monument Record court's ruling, and find that decision is logically limited to those unique circumstances. Applying our holding to the facts presented here, it is evident that the bankruptcy court's order lifting the automatic stay upon the Bank's motion did not have preclusive effect on the Trustee's counterclaims. The only issue properly before the court during that hearing was whether the Bank's claim was colorable, or sufficiently plausible, to lift the stay. The court did not, and indeed, could not adjudicate the substantive merits of either the Bank's claim, or any possible defenses or counterclaims.10 Thus, the issue raised by the Trustee's 10 This is so even if the Trustee had attended the hearing and actually raised any defenses. Thus, the Trustee's absence at the hearing is irrelevant. The Bank contends that the Trustee's failure to deny the allegations in the Bank's motion for relief, and to attend the hearing, constitutes a judicial admission of the validity of the Bank's security interest. The Bank is misguided. Because a court cannot properly adjudicate the validity of a lien during relief from stay proceedings, a party also cannot admit, with preclusive, binding effect, to a claim's validity. See In re Torco Equip. Co., 65 B.R. 353, 355 (Bankr. W.D. Ky. 1986) (preference claim is not a compulsory counterclaim to a motion for relief because of the limited scope of 362 proceedings). To hold otherwise would require a trustee to plead any and all affirmative defenses and counterclaims during the relief from stay proceedings, or be forever barred. -21- preference counterclaim was not before the court at the relief from stay hearing, was not actually (or even implicitly) litigated, and was not essential to the court's decision to lift the stay. Therefore, the elements of issue preclusion are not met here.11 Accordingly, both the bankruptcy court and the district court erred in precluding the Trustee's later counterclaim on those grounds. As we have explained, this is untenable. 11 Moreover, because a relief from stay proceeding merely removes a bar to a creditor from prosecuting its substantive claims, and does not determine the merits of the underlying claim, there is no identity of cause of action between a relief from stay proceeding and an adversary proceeding on the claim's validity. Thus, the elements of claim preclusion are likewise not met here. -22-