On Sept. 23, 2013, in Rodriguez v. Gelman (In re Local Service), 503 B.R. 136 (Bankr. D. Colo. 2013), the U.S. Bankruptcy Court for the District of Colorado addressed an issue of first impression in that district; namely, whether, by virtue of the automatic stay, 11 U.S.C. Section 362, the filing of a bankruptcy petition prevents the attachment of what would otherwise be a valid judgment lien on real property recovered by the debtor after the commencement of the bankruptcy case. On cross-motions for summary judgment filed by a debtor's Chapter 7 trustee and a creditor bank, the court "reluctantly" determined that—contrary to the court's understanding of the principles of statutory construction—the automatic stay did apply to prevent the attachment of the creditor's judgment lien to property acquired by the debtor's estate after the petition date.
This case stems from two bankruptcy cases: one filed by John Watson, a real estate developer who conducted business through numerous entities that he controlled; and the second filed by one of Watson's companies, Local Service Corp. (LSC). Before filing for bankruptcy protection, Watson developed a project called Breckenridge Mountain Estates (BME) through certain of his companies, including LSC. In the summer of 2006, both Watson and LSC conveyed their interests in certain lots of the BME project to another of Watson's companies, Skyline Estates LLC, through the recording of quitclaim deeds. After the conveyances to Skyline of Watson's and LSC's interests in the BME lots, in February 2007, Alpine Bank obtained a default judgment against Watson and LSC in the amount of approximately $2.2 million.
In September 2007, Watson filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code, and listed as one of his assets a 100 percent ownership interest in LSC. After Watson's bankruptcy was converted to a Chapter 7 case and a U.S. trustee was appointed pursuant to Section 701 of the Bankruptcy Code, the trustee caused LSC to file its own voluntary Chapter 11 petition. At the time of these bankruptcy filings, Skyline continued to hold title to the BME lots.
In June 2008, LSC filed an adversary proceeding seeking to recover assets, including the BME lots, which were alleged to have been fraudulently transferred to Skyline by LSC. In that proceeding, LSC (through its trustee) sought to pierce Skyline's corporate veil. The bankruptcy court ultimately entered a default judgment against Skyline that provided, in part, that Skyline and LSC were alter egos of one another, and that Skyline was a corporate fiction designed to shield LSC's assets from creditors. Accordingly, Skyline's interest in the BME lots was awarded to LSC's estate.
LSC's bankruptcy case was subsequently converted to a case under Chapter 7 of the Bankruptcy Code and Simon E. Rodriguez was appointed as trustee in LSC's case. Rodriguez obtained court approval to sell the BME lots free and clear of liens, and then filed an adversary proceeding to determine the validity, extent and priority of liens asserted against the proceeds of the sale of the BME lots, including a lien asserted by the bank.
Positions of the Parties
The bank asserted that it had a lien on the proceeds of the sale of the BME lots due to the unsatisfied judgment lien it had obtained against Watson and LSC in February 2007.
The bank relied upon Colorado's transcript of judgment statute, which provides as follows: "The judgment shall become a lien upon all the real estate, not exempt from execution in the county where such transcript of judgment is recorded, owned by such judgment debtor or which such judgment debtor may afterwards acquire in such county, until such lien expires."
The bank argued that this provision provides for the automatic application of a lien to "after-acquired" real property of a judgment debtor. Therefore, according to the bank, once the BME lots became property of LSC's estate, the bank's judgment lien validly attached to the proceeds of the BME lots post-petition, through operation of the statute.
Rodriguez disagreed, arguing that the automatic stay of 11 U.S.C. Section 362 prevented Colorado's lien statute from taking effect. Both Rodriguez and the bank moved for summary judgment in this adversary proceeding.
The Court's Analysis
The court undertook an in-depth analysis of certain Bankruptcy Code provisions to parse out whether prepetition judgment liens, such as the one asserted by the bank, could attach to property acquired by a bankruptcy estate. The court first examined 11 U.S.C. Section 552(a), which specifically cuts off the operation of after-acquired property clauses, but only in the context of consensual liens, such as those in a security agreement entered into by a debtor. The court noted that because Section 552(a) does not apply to involuntary liens, the rule of statutory construction known as expressio unius est exclusio alterius—where a statute expressly includes certain items, omitted items should be understood to be excluded—provides that because involuntary liens were not included in Section 552(a), there was an inference that this omission should be understood as an exclusion from the statute.
The court went on, however, to a broader analysis and considered the overarching principles of the Bankruptcy Code, which include maintaining the status quo between all of a debtor's creditors, and preventing any creditors from improving their individual positions to the detriment of other creditors. The court considered the automatic stay, which has the dual purpose of both allowing the debtor some breathing room, and also preventing a "race to the courthouse" by creditors seeking to pillage a debtor's assets. The court identified two enumerated exceptions to the automatic stay for the perfection of certain tax liens (11 U.S.C. Sections 362(b)(9) and (18)). According to the court, these exceptions to the automatic stay would be rendered superfluous, in violation of another rule of statutory construction, were the court to hold that automatic stay allowed for the attachment of a prepetition judgment lien to property acquired by the debtor post-petition. The court further supported its position with reference back to an overarching principle of the Code: that of achieving parity among a debtor's creditors. The court noted that if the bank's lien were allowed to attach to the proceeds of the BME lots, the bank would have improved its position vis-à-vis LSC's other creditors. Accordingly, the court held that the automatic stay prevented the attachment of the bank's prepetition judgment lien to the proceeds of the sale of the BME lots, despite the Colorado statute upon which the bank relied.
The court did note that it came to its conclusion "reluctantly" because this was a rare situation where, when following the rules of statutory construction, "there is no credible way to harmonize" the various provisions of the Code. Ultimately, the court assumed that the omission of involuntary liens from the language of Section 552(a) of the Code was likely an oversight. In the absence of binding legal precedent holding otherwise, the court felt compelled to rely on the legislative intent of the Bankruptcy Code to freeze creditors' positions as they existed on the date that the bankruptcy case was filed.
Protect Rights to Any Property of Judgment Debtor
The bank's argument in this case had some appeal, because the real property in question was originally owned by LSC and, but for LSC's fraudulent transfer, the realty would have been property of LSC's estate. However, despite this logical appeal, the bankruptcy court for the District of Colorado has now joined several other jurisdictions in holding that the automatic stay of 11 U.S.C. Section 362 does prevent the attachment of a creditor's prepetition judgment lien to property acquired by a debtor's estate after the petition date. While this had always been the rule for consensual liens, the Colorado bankruptcy court has concluded that judgment liens are also subject to the operation of the automatic stay where property that would otherwise be subject to the judgment lien becomes part of the debtor's Chapter 7 estate. Consequently, judgment lien creditors in all jurisdictions should do what they reasonably can to promptly protect and enforce their rights to any property of a judgment debtor before any bankruptcy filing, including seeking to execute on such judgment or, if appropriate, seeking a lis pendens recordation against the realty. While there can be no guarantee of success, quick action will increase a creditor's likelihood of success.
This article originally appeared in The Legal Intelligencer and is republished here with permission from law.com.
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