Opinion
No. 70 B 128
May 15, 1979
Automatic Stay — State Court Action — Unsecured Provable Debt — Action Sounding In Tort
A municipality's state court action against a bankrupt was not stayed where the action was one sounding in tort and was thus not a provable debt protected by the automatic stay provisions of Bankruptcy Rule 401. In addition, the court refused to use its equitable power to stay the suit, since the estate had, at most, only an indirect interest in the suit's outcome.
Prior to its adjudication, the bankrupt was in the business of purchasing and collecting accounts receivable from physicians which represented claims for money due them for rendering services under the New York State Medicaid program. Approximately five years before its adjudication, the bankrupt had entered into a security agreement in which it had granted a security interest in all current and future receivables to another company. After adjudication, a municipality commenced a state court action against the bankrupt, and alleged that the bankrupt had defrauded the city of over two million dollars. The city sought to obtain relief from the stay provisions of Bankruptcy Rule 401 in order that it could proceed against the bankrupt in the pending state court action. The trustee opposed lifting of the stay and, alternatively, requested that the city be enjoined, under Section 2a(15) of the Bankruptcy Act, from prosecuting the state action.
The court observed that the automatic stay granted by Bankruptcy Rule 401 enjoins, inter alia, the continuation of any action against the bankrupt if the action is founded on an unsecured provable debt. The court then cited the case of In re Crimmins, CCH Bankruptcy L. Rep., ¶ 66,012, where it was observed that a reading of the list of "provable debts" in Section 63a and of the list of exceptions to dischargeability in Section 17a reveals that the dividing line between the two groups is drawn so as to place all the contractual and quasi-contractual claims in the former category and, with one exception, all the claims sounding in tort in the latter.
The gravamen of the pending state suit, noted the court, revolved around allegations that the bankrupt engaged in a systematic scheme to convert to its use and benefit funds belonging to the city. The methods allegedly employed by the bankrupt were illegal use of voided official checks and alteration and falsification of certain documents. Thus, the court concluded that the city's pending state causes of action were ones sounding in tort and were not provable debts "protected by the umbrella" of Bankruptcy Rule 401.
In the alternative, the bankrupt contended that the court should exercise its equitable powers under Section 2a(15) of the Bankruptcy Act to restrain the city from proceeding with its state court action. Section 2a(15), observed the court, merely codifies the inherent power of a court of equity. The test to be applied in determining under what circumstances a court should exercise this equitable power to enjoin the prosecution of a suit in a non-bankruptcy proceeding is whether the proceeding will interfere with the possession or custody of the bankruptcy court, or unduly impede or embarras the court in its administration of the estate.
The record here, observed the court, is devoid of any showing that would trigger resort to the extraordinary remedy requested. No matter what the outcome of the pending state action, reasoned the court, no money would conceivably come into the estate since the security interest of the putative assignee would more than swallow any possible recovery by the bankrupt. If the estate, as here, has no interest, or only an indirect interest in the outcome of the suit, it will not be stayed. Accordingly, the court ruled that the city could proceed with its pending state court action. See Sec. 2a(15) [§ 105] at ¶ 7045 and Bankruptcy Rule 401 at ¶ 20,121.